A lot can change in a year. At this time last year, the world was facing an unprecedented economic and health crisis. There were concerns that the loss of economic activity would affect demand which could cause the economy to go into a deflationary spiral. As a result, the central banks injected trillions of liquidity into financial markets, the federal government spent trillions to help small businesses and individuals, and companies started aggressively cutting costs to preserve cash.

Today much has changed, and it's clear that the worst of the economic and health crisis is behind us. In a year, commodity prices went from multi-year lows to new highs in many instances. Rather than being concerned about deflation, inflation seems to be the biggest concern.

While investors should continue to monitor inflation data, it's far from being a significant threat to the bull market or economic recovery. Here are three reasons why:

1. YoY Comps are Misleading

We are certainly seeing higher inflation readings across numerous metrics whether it's consumer prices, producer prices, or commentary from companies on earnings calls. For example, the latest CPI for April showed a 4.2% increase in prices from last year, and the PPI showed a 6.2% increase.

However, this data is misleading given the extreme circumstances around last year. Prices were plummeting as demand was quite low during the pandemic. In hindsight, demand quickly recovered due to stimulus payments, however, companies reduced supply and production which is leading to higher prices now as demand remains quite strong. Therefore, the higher readings are more of a reflection of the unique circumstances of the past year in terms of supply and demand rather than a true picture of the inflation circumstance.

2. Corporate Net Profit Margins Remain Strong

It's certainly true that at a certain point inflation is negative. It eats into consumer spending with higher gasoline, food, and rent spending. Companies' profit margins start to erode as they have to pay more for inputs. The Federal Reserve is forced to tighten monetary policy.

However, it's clear by many measures that we are not there yet. The most salient is corporate profit margins were quite strong in Q1 and near the high-end historically. This shows that companies are able to pass on higher costs to consumers.

3. Inflation Spikes During Recoveries are Normal

Finally, it's quite normal for inflation to spike early in a recovery. During the recession, bankruptcies and consolidations lead to lower production levels. At the same time as the economy starts to recover, there's a burst of economic activity due to pent-up demand being unleashed.

This leads to a short-term surge in inflation until companies respond by increasing production and then supply and demand to find a new equilibrium. We are going through that same exact process. However, it will be more extreme given the unusual circumstances created by the pandemic which has resulted in a bigger demand spike and more supply constraints.

Yet, we can be confident that capitalism and markets will continue to work. Higher prices will incentivize more production. More production will lead to falling prices and relieve the inflation worries.