Shelter component of CPI offers clues about inflation

For investors trying to get a handle on whether inflation is transitory or more permanent, the shelter component of the consumer price index is a good place to start, a Los Angeles-based portfolio manager says.

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The U.S. Labor Department’s September inflation print came in at 5.4%, the fifth consecutive month above 5%.

“It’s been quite a bit of a pickup since the pandemic, but this fifth consecutive print, it hardly strikes me as transitory,” said Samuel Lau, a portfolio manager with DoubleLine Capital. “I think that these elevated levels of inflation will likely be with us at least through year-end of 2022.”

Most economists have focused on rising input costs from higher commodity prices, supply chain issues and lack of inventory related to the pandemic as indicators of the inflationary path. Lau said those factors are important, especially heading into the winter as fuel demand rises for heating homes. But he’s also focusing on the housing market.

One area Lau turns to is the shelter component of the CPI basket, which comprises home rentals. According to Lau, shelter — which accounts for roughly one-third of the total CPI basket — was up 3% year-over-year and has been steadily increasing since the depths of the pandemic-led recession. 

“The shelter component is important in determining future inflation,” said Lau, whose firm manages the Renaissance Flexible Yield Fund.

Historically, there’s a strong relationship between the shelter component and the path of home price appreciation, he said, with a lag of around 12 to 18 months.

“That’s another way of saying that home price appreciation has been a pretty good predictor of future shelter inflation,” Lau said.

U.S. home prices are one of the few economic measures that didn’t plunge during the course of the pandemic in 2020, Lau said, and they’ve risen steadily since. A large contributor to that price growth is the number of available units for sale, which hit its lowest point on record in January 2021, at just over 1 million homes on the market, Lau said. Today, that number is just shy of 1.3 million units available for sale.

“There’s been a dearth of supply relative to the amount of demand,” Lau said. 

On top of that, accommodative monetary policies have pushed down mortgage rates, keeping the cost of buying a home relatively low.

“You also have factors like the work-from-home or hybrid environment, which has really opened up new possibilities of working from a new home in an entirely different city. The last 18 months or so have been on fire for the housing market,” Lau said. 

The S&P/Case-Shiller U.S. home price index has seen double-digit year-over-year growth each month since December of last year, he said.

Lau said research from the Dallas Federal Reserve showed the “massive run-up in home prices” will cause the shelter component of inflation to accelerate next year and reach a 7-8% year-over-year increase by the end of 2023.

The shelter component, combined with supply chain issues and commodity prices, mean inflation will remain elevated through next year, he said.

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