Economy Picks Up Steam—Is Inflation Next?

Just in: The economy is growing at a nice clip.

Today’s report of third-quarter economic growth showed a 2.9% increase, higher even than most optimistic analysts expected and more than twice as fast as the 1.1% growth in the year’s first half.

Strong exports and healthy consumer spending fueled the impressive quarter. Inventory replenishment also played a part, as businesses boosted investment despite a high level of uncertainty about the direction of interest rates and the presidential election.

What does this mean for investors? Three things:

Interest rates are going up. We already knew they were headed higher, but this pretty much ices it. Unless we experience a truly traumatic economic event in the next two months, look for the Federal Reserve to boost rates in December.

Earnings could be better than expected. Third-quarter earnings marked the end of the “earnings recession,” several quarters in a row in which the S&P 500’s overall earnings were negative. In the next three quarters, lots of companies will be posting year-over-year results with relatively easy comparisons.  If the economy is also growing faster than the consensus believes, earnings should get a boost, too—especially for companies deriving most of their profits from the U.S. economy.

Inflation could rear its ugly head. There’s little sign of inflation in the economy today; consumer prices rose only 1.5% for the 12 months ended September. There’s not even much sign of inflation on the horizon. But like those complex locks that need several pieces to fall into place to open, inflation picks up only when other elements are already apparent.

One is low unemployment, because it leads to wage growth. Another is a healthy housing market, which increases demand for a range of products and services. Rising commodity prices directly influence inflation, and we’re seeing a bit of a renaissance there as well (though not across the board). Finally, inflation tends to pick up when the dollar weakens, a scenario that hasn’t been the case of late, but the dollar could retreat in the coming months from its recent impressive highs.

Inflation is the really interesting element here, and clearly the Fed’s moves over the next six to 12 months to curb that threat will influence stocks, bonds and other investments. A strong economy and higher inflation likely would lead to more rate hikes, but if unemployment ticks up for any reason (including idle men re-entering the workforce). the Fed’s hands could be tied.

Higher inflation could be a big boon to precious metals, which tend to rise with general prices as investors seek inflation hedges. Silver is especially attractive today; its price has been rising for fundamental reasons, and there’s ample reason to believe the bull run is far from over. But don’t take my word for it—Jim Fink has the full story, and a trade that could be hugely lucrative, right here.

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