Notes on Inflation and Forestry Investments

On April 12, 2022, a release from the U.S. Bureau of Labor Statistics (BLS) reported that, for the twelve-month period ending in March 2022, U.S. inflation increased 8.5%. According to BLS, this was “the largest 12-month increase since the period ending December 1981.” Whew! Inflation is the general increase in prices and wages over time and the associated (and unpleasant) reduction in the buying power of money. Importantly, inflation speaks to a broad and overall increase in prices, not to higher prices for individual items.

This last point reminds us that some price changes affect us more than others, and that different people and firms buy different things. My higher cost is your higher profit. So, let’s review components of recent inflation trends and their relevance to the forest industry.

Q1 2022: A Crazy Quarter

In January, twelve-month inflation reached 7.5%. Gwynn Guilford at The Wall Street Journal broke down the BLS data into key components: the 7.5% included Food (~1.0) plus Energy (~1.7) plus Everything Else (~4.8). Within Energy, 1.2 of the 1.7 reflected higher gasoline prices. Within Everything Else, ~1.1 was used cars, ~0.5 was new cars, and ~1.5 was housing (e.g. home prices and rent).

To summarize the twelve-month data as of January, food and gasoline and cars/trucks and housing accounted for most of the hit on consumer prices. January proved painful for true pocketbook items. In addition, Russia had yet to invade Ukraine; that happened in February.

The topline numbers for March, 8.5% year-over-year, while higher than January, had more nuance. While gasoline prices were heavily impacted by disrupted oil supplies from Russia’s invasion of Ukraine, we observed gas prices falling from offsetting, increased U.S. production. While grocery prices remained higher, restaurant (dining out) prices eased. While new car prices remained high and constrained by chip shortages, used-vehicle prices fell in March. In addition, overall housing costs moderated since January.

To summarize, March quantified the economic impact of Russian aggressions on already higher energy and food costs (thanks, Vlad). Looking forward, the resurgence of COVID in China (and potential supply chain repercussions) and the continuing invasion of Ukraine remain worrisome (and troubling).

Forest Industry and Investment Implications

In the book Forest Finance Simplified, I summarize research by Steven Bullard and John Gunter published in the Southern Journal of Applied Forestry (“Adjusting Discount Rates for Income Taxes and Inflation”) to provide a step-by-step process for adjusting discount rates to account for inflation in discount rates. In their article, Bullard and Gunter note how “forestry investments are most accurately evaluated when the analysis is done in nominal terms on an after-tax basis.”

Inflation does affect the investor mindset. While the relationship between assets prices (values) and inflation is complicated and its own field of research, the implication for investors prioritizes the understanding of how cash flows from each asset type. In the forest industry, that means evaluating the costs and revenues for timberland, sawmills, and pulp facilities over time to assess how they respond to inflation.

Generally, institutional investors and individuals prefer illiquid assets during inflationary periods. These assets – including well-managed private businesses, infrastructure, manufacturing assets, and timberland – tend to appreciate and increase cash flows when prices rise. While these assets are not immune to inflation from higher costs (e.g. energy), forest industry assets seem to provide an effective operating platform during inflationary periods.