1/24/22
By Mark Sauer
On Wednesday January 12th the U.S. Bureau of Labor Statistics announced a key inflation gauge – CPI (Consumer Price Index) – has climbed to 7% over the past year. The steepest increase since June of 1982.
Inflation is broadly understood – but let’s start with its official definition:
In economics, the term ‘inflation’ refers to a general progressive increase in prices of goods and services within an economy. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation corresponds to a reduction in the purchasing power of money.
If your income goes up, in direct correlation to the rising cost of goods and services, then you’re no better or worse off. However, for so many Americans, this is not the case, as many of us live on a fixed income source.
What are the current causes of inflation?
- Pent-up consumer demand following a year of lock-down
- Generous government support – via the printed of trillinions and creasing the money supply nearly 50% through 2020/2021 – including cash infusions to businesses and unemployment benefits
- Employers finding it hard to hire labor and fill positions
- Supply chains under pressure due to trade wars and the de-globalization movement
- Bottlenecks throughout the logistics chain
In addition to these converging factors, the Fed is projected to raise rates a full percentage point, or 100 basis points, in an effort to start shrinking the size of its $8.8 trillion balance sheet.
While the causes of inflation are many, we believe that the effects of inflation have been, until recently, underappreciated or poorly understood. With inflation being largely irrelevant over the last 40 years – resting around 2% annualized – we can now say with confidence that it is alive and well. And it must be managed in our personal financial lives if we hope to stay ahead of it.
How we’re Managing Inflation Risk
It’s most important at this time to avoid large cash holdings or traditional ‘preservation of principal’ investments such as bonds. Bonds have played a crucial role in portfolio construction for decades. They have admirably performed a dual role of income generation and capital preservation in millions of portfolios. However, given the new reality of low yields and rising inflation, that dual role is threatened. Cash, on the other hand, can often play a strategic role during down markets to buy at lower prices. With Fed rate hikes coming throughout ‘22 they will surely usher in market volatility. Volatility can be frightening, but we believe it will present an opportunity to put cash to work. After all, the long-term trend of the market is always up.
For Aggressive Investors:
Own more of the broad Market. During times of hyperinflation there’s no better place to keep up than being invested in stocks. This has resulted in our choice to move more of our investor’s assets into the broad market while holding few individual stocks. The market has proven to be difficult to navigate throughout 2021; however, if you simply owned the S&P 500 you would have found a generous 26.9% return. As they say, “rising tides raise all ships”. A broadly diversified portfolio in the stock market has proven to be a winning strategy to stay ahead during inflationary periods.
Make Crypto & Web3 investments. Crypto is a powerful new financial tool that is an inevitable part of the future economy. While volatile, and unlike traditional currencies, it has proven to create tremendous financial returns for its holders. The crypto markets are largely unregulated and, therefore, full of ponzi schemes and scams – be wary. However, there is a tremendous amount of utility that will come from the world of blockchain and Crypto currencies are just the beginning. Investing a small portion of your investment portfolio into utility driven currencies is a great way to build long-term wealth. Bitcoin is already being considered ‘digital gold’ and will soon be globally adopted as such. Investments like Etherium, Solana, Ripple, Cardono, Stellar Lumis and many others may be referred to as ‘currencies’ but ultimately represent the ownership of blockchain technology companies – similar to owning stock in publicly traded technology companies like Apple or Google. Building a diversified portfolio of these investments will prove fruitful in the long-term for those aggressive enough to weather its short-term, volatile nature.
Growth + Income Investors
Buy Real Estate – If you don’t own a home, income properties or other real estate investments, now may be a good time to lean more heavily on REITs (Real Estate Investment Trusts) which are offered in many forms. REITs give investors the opportunity to invest small amounts of capital into a diversified portfolio of real estate holdings. REITs can also be a great place to generate income for their holders.
Buy Income Generating Stocks. By owning a stock you can realize appreciation over time. With dividend paying stocks you gain access to cash generation now, while riding the wave of potential future equity appreciation. This is a winning strategy for both aggressive and conservative investors – especially during hyperinflationary periods.
Ultra Conservative Investors
As mentioned, Bonds have played a crucial role in portfolio construction for decades. But their low yields at a time of rising inflation threaten your ability to keep up. Owning Dividend paying stocks is a great way to compliment an ultra conserviative portfolio. This may feel too aggressive for some investors, however, the risk of losing principal during hyperinflation is arguably just as risky depending on the use case and the investments you choose. However, there are a few strategies we would recommend, in addition to holding some dividend paying stocks for those in need of further comfort.
Buy Gold. Gold has often been considered a hedge against inflation. In fact, many people have looked to gold as an “alternative currency,” particularly in countries where the native currency is losing value. Depending on the macro conditions, there may be better assets to invest in when aiming to protect yourself against inflation. However, like any strong portfolio, diversification is key, and gold is always a worthwhile consideration for hyperinflationary environments like we’re in today.
Buy TIPS (Treasury Inflation-Protection Securities). A type of U.S. Treasury bond, TIPS are indexed to inflation in order to explicitly protect investors from inflation. Twice a year, TIPS payout at a fixed rate. The principal value of TIPS changes based on the inflation rate, and so the rate of return includes the adjusted principal.
The Bloomberg Barclays Aggregate Bond Index. A market index that measures the U.S. bond market. All bonds are covered in the index: government, corporate, taxable, and municipal bonds. To invest in this index, investors can invest in funds that aim to replicate the performance of the index. Though this is likely the one of the lowest returning, of our recommended inflation protecting strategies, it is effective in preserving principal and returning a steady coupon (income payment) in alignment with the bond market.
If you’d like to learn more about how we manage risk for our investors please read our last blog post: How We Manage Risk – Offensively.
