Category Archives: Inflation

Inflation Comes in Hotter than Expected

Posted on by

The consumer price index for all items rose 0.6% in January, driving up annual inflation by 7.5% which marked the biggest gain since February 1982

The consumer price index (CPI), which measures the costs of dozens of everyday consumer goods, rose 7.5% compared to a year ago vs. an estimate of 7.2%, the Labor Department reported.

Consumer prices in January surged more than expected over the past 12 months, indicating a worsening outlook for inflation and cementing the likelihood of substantial interest rate hikes this year, reports CNBC.

The closely watched inflation gauge was the highest reading since February 1982. On a percentage basis:

  • Fuel oil rose the most in January, surging 9.5% as part of a 46.5% year-over-year increase.
  • Vehicle costs, which have been one of the biggest inflation contributors since it began surging higher in the spring of 2021, were flat for new models and up 1.5% for used cars and trucks in January.
  • Shelter costs, which make up about one-third of the total CPI number, increased 0.3% on the month and is up 4.4% over the past year and could keep inflation readings elevated in the future.
  • Food costs jumped 0.9% for the month and are up 7% over the past year.

The hotter-than-expected inflation reading may prompt the Federal Reserve to accelerate interest rate hikes — a full percentage point increase by the start of July, according to CNBC.

References:

  1. https://www.cnbc.com/2022/02/10/january-2022-cpi-inflation-rises-7point5percent-over-the-past-year-even-more-than-expected.html

Fear of Higher Interest Rates Ending Technology Stocks Growth

Posted on by

Technology stocks have been the driving force behind the longest-running bull market in history.

The technology sector is vast, comprising gadget makers, software developers, wireless providers, streaming services, semiconductor companies, and cloud computing providers, to name just a few, according to Motley Fool. Any company that sells a product or service heavily infused with technology likely belongs to the tech sector.

And, the pandemic has been mostly positive for the tech industry. Companies like Amazon have thrived as consumers shifted hard toward e-commerce. Additionally, companies like Microsoft have also done well, buoyed by demand for collaboration software, devices, gaming, and cloud computing services as people spend more time at home.

Many of the most valuable companies in the world are technology companies.

Growth stocks have outperformed for 12 years and counting. Since the end of the Great Recession in 2009, growth stocks have been a driving force on Wall Street. Many of the most valuable companies in the world, like Apple and Microsoft, are technology companies.

Historically low lending interest rates and the Federal Reserve’s ongoing quantitative easing measures have created a pool of abundant cheap capital that fast-paced businesses have used to expand operations and investors have used to fuel the longest running bull market.

Technology stocks have been a key component of the market’s rising trend. Since the financial markets collapsed, demand for consumer electronics and related products and services has caused the tech sector to far outperform every other segment. 

However, revenue growth is starting to slow, although the delta variant surge may drive consumers away from stores once again. The economic dynamics favoring technology’s 12 year growth are changing.

Inflation is running rampant, and the Federal Reserve has indicated it’s become more hawkish on fighting it, indicating as many as three interest rate hikes may be in the cards calendar year 2022, effectively ending its loose money policy. Higher interest rates hurt growth stocks because growth stocks intrinsic value is based on the value of their future earnings. And, those future earnings are not worth as much if interest rates go up.

To best analyze tech stocks, first determine if the company is profitable or not.

For mature tech companies that produce profits, the price-to-earnings ratio is a useful metric. Divide stock price by per-share earnings and you get a multiple that tells you how highly the market values the company’s current earnings. The higher the multiple, the more value the market is placing on future earnings growth.

Many tech companies aren’t profitable, so the price-to-earnings ratio can’t be used evaluate them.

Revenue growth matters more for these younger companies.

If you’re investing in something unproven, you want to make sure it has solid revenue growth.

For unprofitable tech companies, it’s important that the bottom line be moving from losses toward profits.

As a company grows, it should become more efficient, especially when it comes to the sales and managing expenses. If it’s not, or if spending is growing as a percentage of revenue, that could indicate something is wrong.

Ultimately, a good tech stock is one that trades at a reasonable valuation given its growth prospects.

Accurately figuring out those growth prospects is the hard part. If you expect earnings to skyrocket in the coming years, paying a premium for the stock can make sense. But if you’re wrong about those growth prospects, your investment may not work out.

Thus, investing in technology stocks can be risky, but you can reduce your risk by investing only when you feel confident their growth prospects justify their often lofty price to earnings valuations.

References:

  1. https://www.fool.com/investing/2022/01/20/2-top-tech-stocks-ready-for-a-bull-run/
  2. https://www.fool.com/auth/authenticate/
  3. https://www.fool.com/investing/stock-market/market-sectors/information-technology/

Inflation – The Elephant Affecting the Economy

Posted on by

Historic inflation and interest rates hike fears are sinking many high growth technology stock prices. Inflation in 2021 was the consequences of rapidly rebounding demand in a supply-constrained world.

The fear of inflation and the the fear of subsequent Federal Reserve interest rate hikes are creating concern and panic among some investors. Rising interest rate and skyrocketing inflation worries are pressuring stocks. And by the Fed signaling raising rates in the future, it unsettles and sends both Wall Street and Main Street into a panic.

But, what is inflation?

Inflation is when consumer prices rise, goods and services become more expensive, and money loses value. Inflation reduces your purchasing power, eats away at your investment returns, and chips away at your wealth. Currently, Americans are experiencing the pernicious effects of inflation, especially in the areas of escalating food and energy prices.

2021 was one of the worst years for inflation that Americans have seen recently, with a 7% increase, the highest since 1982. For consumers, this means $1 at the beginning of the year was roughly worth only $0.93 at the end. While the impact might seem small when examining it on a dollar level, it represents a change in the purchasing power of retirement savings from January 2021 to December 2021. The Wall Street Journal’s Gwynn Guilford writes: “U.S. inflation hit its fastest pace in nearly four decades last year as pandemic related supply and demand imbalances, along with stimulus intended to shore up the economy, pushed price up at a 7% annual rate.”

American economist and Nobel prize laureate Milton Friedman opined that: “Inflation is always and everywhere a monetary phenomenon.”  In other words, inflation is invariably a case of too much cheap money and capital chasing too few goods, services and assets.

In the last twenty years, the United States witnessed a large accumulation of federal public debt under Presidents Bush, Obama, Trump, and Biden administrations. Federal debt climbed from 55% of GDP in 2002 to 105% in 2019. Additionally, the U.S. has also endured a decade plus of loose monetary policy overseen by the Fed which has pumped up asset prices.

As a result of the escalating public debt and loose monetary policy, the Federal Reserve most important immediate task, of its dual mandates, must be to get inflation under control and reduced. Since 1977, the Federal Reserve has operated under a mandate from Congress to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates”—what is now commonly referred to as the Fed’s “dual mandate.”

The Labor Department stated that the consumer-price index — which measures what consumers pay for goods and services — rose 7% in December from the same month a year earlier, up from 6.8% in November. That was the fastest growth in inflation since 1982 and marked the third straight month in which inflation exceeded 6%.”

Three sectors–energy/materials, financials and technology–may be viewed as inflation beneficiaries or, at the very least, inflation-agnostic assets:

  • Energy and materials are commodity-based, and oil, gas, and most commodities rebounded from prices that had fallen to a fraction of their pre-pandemic levels.
  • Financials, especially banks, are often viewed as inflation hedges since interest rates historically climb when inflation heats up. This reflects the eroding effect of higher prices on a currency’s value in the future, which is remedied by rate hikes on debt.
  • Technology is a more nuanced winner in the inflation game. The large tech players and most software companies have tremendous economies of scale. As their revenues scale, their costs, particularly labor, do not grow at nearly the same degree, cushioning profit compression from wage escalation.

In a book called “The Great Inflation”, the authors wrote, “Inflation is not an Act of God…inflation is man-made and can be started, prevented, regulated and stopped by human action.”

“To think that a stimulus of this magnitude wouldn’t cause inflation required believing either that such a huge adjustment was possible within a matter of months, or that fiscal policy is ineffective and does not increase aggregate demand. Both views are implausible”, says Jason Furman, former chair of President Obama’s Council of Economic Advisers.

Thus, slowing down in aggregate federal debt growth per capita, tightening monetary policy, and raising interest rates could be effective tools in stemming runaway inflation.

“If I was Darth Vader and I wanted to destroy the US economy, I would do aggressive spending in the middle of an already hot economy… What are you going to get out of this? You’re going to get a sugar high, the higher inflation, then an economic bust.” — Billionaire investor Stanley Druckenmiller, July 23, 2021

References:

  1. https://www.cnbc.com/2021/12/13/op-ed-these-3-market-sectors-shone-even-as-investors-grew-weary-of-hearing-about-inflation.html
  2. https://www.americanthinker.com/blog/2021/12/is_joe_manchin_right_about_inflation.html
  3. https://seekingalpha.com/article/4479557-how-to-better-understand-inflation-and-predict-its-direction
  4. https://www.marketwatch.com/story/why-did-almost-no-one-see-inflation-coming-11642519667

Inflation…Highest Level in 40 years

Posted on by

Inflation is at its highest level in 40 years as December prices rose 7 percent, compared to a year earlier

As a reaction to the COVID-19 pandemic and subsequent shutting down of the economy, Congress and the Federal Reserve responded with a wave of fiscal and monetary stimulus which was and remains without historical precedent.

Thus, we are in the midst of a fiscal and monetary experiment which has no direct antecedents. This renders all economic theories and financial forecasting hugely speculative.

As the second year of the pandemic fades away, Americans are experiencing the ravages of inflation. Prices, as depicted by the Consumer Price Index (CPI*), rose at the fastest pace in 40 years in December, increasing 7 percent over the same period a year ago, reported by the U.S. Bureau of Labor Statistics. The Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services.

Correspondingly, calendar year 2021 will go down as the worst year for inflation since 1981, as broken supply chains and higher energy prices collided with high consumer demand for used cars and construction materials, according to the Washington Post.

The energy index rose 29.3 percent over the last year, and the food index increased 6.3 percent, according to U.S. Bureau of Labor.

Higher prices have permeated into just about everything American households and businesses buy, raising alarms for policymakers at the Federal Reserve and White House that inflation has spread throughout the greater economy, the Washington Post reported. Additionally, officials within the Federal Reserve and President Biden administration expect high inflation will persist through much of calendar year 2022.

Federal Reserve Chairmen Jerome Powell said it was essential to get prices down to more sustainable and stable levels to ensure a lasting recovery. “If inflation does become too persistent, if these high levels of inflation become too entrenched in the economy or people’s thinking, that will lead to much tighter monetary policy from us, and that could lead to a recession and that would be bad for workers,” Powell told Congressional lawmakers.

References:

  1. https://www.bls.gov/news.release/cpi.nr0.htm
  2. https://www.washingtonpost.com/business/2022/01/12/december-cpi-inflation/
  3. https://www.bls.gov/cpi/
  4. https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category-line-chart.htm

* The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

Inflation: Biggest Threat to Investors and Market

Posted on by

“Inflation is not going to be transitory.” Paul Tudor Jones, Tudor Investment Founder

Recently on CNBC, Paul Tudor Jones, founder and chief investment officer of Tudor Investment Corporation, was extremely critical of current Federal Reserve policy. He opined that current Fed monetary policy and Administration fiscal policy are creating persistent inflation, instead of fighting existing inflation.

In his opinion, inflation could be worse than feared and is not transitory. “I think to me the number one issue facing Main Street investors is inflation, and it’s pretty clear to me that inflation is not transitory,” Jones said on CNBC’s “Squawk Box”. “It’s probably the single biggest threat to certainly financial markets and I think to society just in general.”

Additionally, Jones opined that inflation will be the death to 60 percent stocks / 40 percent bond portfolios favored by retirees. In his opinion, the Federal Reserve policy is creating inflation instead of fighting it. Instead, the Fed should be aggressively fighting inflation.

Currently, the Fed is slow and late fighting inflation.

Jason Furman, the former chair of the White House Council of Economic Advisers and now a professor at Harvard University’s John F. Kennedy School of Government, contends that both economists, and the market, got inflation wrong in 2021. Furman explained that normal multipliers showed that the fiscal and monetary stimulus was well in excess of the economy’s potential to absorb. He expects inflation to remain “very elevated” because demand will be above trend, and the lag from Federal Reserve policy will mean any tightening won’t make an impact until next year anyway.

Consumer inflation expectations

A Sept. 2021 Federal Reserve Bank of New York survey shows Americans’ inflation rate expectations rising to their highest levels since the survey’s inception.

Consumer expectations for inflation rose to 5.3% over the next year and 4.2% over the next three years, according to the New York Fed. Both are the highest in the history of a data series that goes back eight years.

Powell has long held that inflation is being held in check by forces that the Fed has no control over – aging populations, lower productivity and advances in technology.

Powell’s five-point inflation checklist include:

  • Lack of broad-based pressures;
  • Lower moves in high-inflation items;
  • Low wage pressures;
  • Tepid inflation expectations, and
  • Long-lasting forces that have kept inflation low globally.

High technology companies stocks have underperformed the broader markets amid an increasing possibility of Federal Reserve rate hikes this year. Rising U.S. treasury yields have also recently put pressure on high growth tech names.

The valuations of many tech companies rely on the prospect of profits years in the future, and higher long-term Treasury yields typically discount the present value of future cash.

References:

  1. https://www.msn.com/en-us/money/savingandinvesting/here-s-the-market-move-cathie-wood-says-is-ridiculous-as-her-flagship-fund-sputters/ar-AASCrQL
  2. https://www.aeaweb.org/conference/2022/livecasts/inflation
  3. https://www.cnbc.com/2021/10/20/paul-tudor-jones-says-inflation-could-be-worse-than-feared-biggest-threat-to-markets-and-society.html

Inflation and the Bond Market

Posted on by

The bond market—Treasuries, high-grade corporate bonds, and municipal bonds—are experiencing depressed yields in the 1% to 3% range and near-record negative real rates with inflation running at 6%. Barron’s

Real interest rates can be effectively negative if the rate of inflation exceeds the nominal interest rate, according to Investopedia. Real interest rate refers to interest paid to borrowers minus the rate of inflation. There are instances, especially during periods of high inflation, where lenders are effectively paying borrowers when they, the borrowers, take out a loan. This is called a negative interest rate environment.

The real interest rate is the nominal interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or to a bond investor. The real interest rate is calculated as the difference between the nominal interest rate and the inflation rate:

Real Interest Rate = Nominal Interest Rate – Inflation (Expected or Actual)

While the nominal interest rate is the interest rate actually paid on a loan or bond, the real interest rate is a reflection of the change in purchasing power derived from a bond or given up by the borrower. Real interest rates can be effectively negative if inflation exceeds the nominal interest rate of the bond.

There is risk for bond returns in 2022, when the Federal Reserve is widely expected to start lifting short-term interest rates to manage inflation.

And things could get worst for bonds if inflation persists. That could force the Fed to tighten more aggressively. It wouldn’t take a big rise in rates to generate negative returns on most bonds. The 30-year Treasury, now yielding just 1.9%, and most municipals yield 2% or less and junk bonds yield an average of 5%. Bonds would drop significantly in price if rates rise a percentage point.

The real interest rate adjusts the observed market interest rate for the effects of inflation.

“Cash has been trash for a long time but there are now new contenders for the investment garbage can. Intermediate to long-term bond funds are in that trash receptacle for sure.” Bill Gross, “Bond King”

References:

  1. https://www.barrons.com/articles/best-income-investments-for-2022-51640802442
  2. https://www.investopedia.com/terms/n/negative-interest-rate.asp

Inflation: The Elephant in the Room

Posted on by

November’s CPI report showed consumer prices rising at rates last seen four decades ago.

Inflation is the biggest risk facing the equity market and is likely to end the record long bull-market. Inflation has a long history of eroding the value of financial assets and brings with it higher interest rates as central bankers try to tamp it down.

The annual inflation rate accelerated significantly in 2021, from about 0.5% at the start of the year to over 3% by September. This was driven by increased demand as the economy reopened and by a sharp rise in energy prices, among other factors.

In October, inflation measured by the consumer price index was up 6.2% from a year earlier, the highest annual rate since November 1990. It marked the sixth straight month above 5%. Kiplinger expects inflation to hit 6.6% by year-end 2021 before falling back to 2.8% by the end of 2022 – above the 2% average rate of the past decade.

“Inflation is in the air, and it risks becoming a market issue, an economic issue and a political issue,” says Katie Nixon, chief investment officer at Northern Trust Wealth Management.

As we enter 2022, inflation is expected to remain a risk amid higher food and gas prices, rising pressures from non-energy industrial sectors such as steel and chemicals, higher food and consumer goods prices, and increases in the energy prices.

Economists expect headline CPI to peak between 4.5% and 5% in the first half of 2022 and approach 2.5% year over year by the end of 2022.

References;

  1. https://www.kiplinger.com/investing/stocks/stocks-to-buy/603814/where-to-invest-in-2022
  2. https://investor.vanguard.com/investor-resources-education/article/simple-strategies-for-reducing-inflation-risk

Beat Inflation with Dividend Stocks | Fidelity Viewpoints

Posted on by

“Stocks that can boost dividends during periods of high inflation may outperform.” Fidelity Viewpoints

Key takeaways according to Fidelity Viewpoints

  • Dividends aren’t just nice to have, they’re essential to the stock market’s return—accounting for approximately 40% of overall stock market returns since 1930.
  • During periods of high inflation, stocks that increased their dividends the most considerably outperformed the broad market, on average, according to Fidelity’s sector strategist, Denise Chisholm.
  • Dividend-paying stocks’ regular, scheduled payments also may help to reduce the volatility of a stock’s total return.

The economy is gradually recovering from its pandemic-related slowdown and shutdowns, and inflation has hit its highest rate in 39 years. People are emerging from the pandemic and are spending money they saved or money they’re getting from the government. Thus, a combination of soaring pent-up consumer demand and persistent supply chain disruptions has tarnished an otherwise robust economic recovery.

The Bureau of Labor Statistics said the Consumer Price Index of food, energy, goods and services rose by 0.8 percent in November, pushing annual inflation above 6.8 percent. The level is the highest since 1982 and it also marked the sixth consecutive month in which annual inflation rates have exceeded 5 percent.

Currently, approximately 70 percent of Americans rate the economy negatively, with nearly half of Americans blaming Biden for inflation, according to a recent Washington Post-ABC poll.

This combination of economic challenges and consumer worries may make this an especially good time to consider investing in stocks that pay consistent dividends.

A few important things for investors to know about dividend stocks:

  • Dividend payouts typically happen quarterly, although there are a few companies that payout monthly.
  • Many high-quality companies routinely raise their dividend payouts, helping hedge against inflation.
  • A stock’s dividend yield moves in the opposite direction of its stock price, all else being equal, so a high yielding stock may be reason for caution.

Fidelity research finds that dividend payments have accounted for approximately 40% of the overall stock market’s return since 1930. What’s more, dividends have propped up returns when stock prices struggle.

Dividends account for about 40% of total stock market return over time

US stock returns by decade (1930–2020). Over various decades, dividends have remained a fairly steady component of stocks’ total returns amid more highly volatile stock prices. Past performance is no guarantee of future results. Source: Fidelity Investments and Morningstar, as of 12/31/2020.

To invest successfully in dividend stocks, one of the keys is finding companies with strong balance sheets and with secure payouts that can grow consistently over the long haul. Moreover, it’s important to understand the concept of dividend yield, which investors use to gauge how much dividend income their investment will produce.

Investing in dividend stocks

When selecting dividend stocks, it’s important to keep dividend quality in mind. A quality dividend payout can grow over time and potentially be sustained during economic downturns. It’s the primary reason investors must not focus solely on yield.

Steve Goddard, founder and chief investment officer of Barclay, prefers companies with high returns on capital and strong balance sheets. “High return-on-capital companies usually by definition will generate a lot more free cash flow than the average company would,” he says. And cash flow is what pays the dividend.

Although overall dividend health has improved markedly since 2020 and looks good heading into 2022, it’s equally important to check a company’s dividend policy statement so you know how much to expect in payment and when to expect it. Dividend yield is a stock’s annual dividend expressed as a percentage of its price.

It’s crucial to recognize that a stock’s price and its dividend yield move in opposite directions, as long as the dollar amount of the dividend doesn’t change. Investing in the highest-yielding shares can lead to trouble, notably dividend cuts or suspensions and big capital losses

This means a high dividend yield may be a red flag of a problem with the underlying company. For example, a stock’s yield may be high because business problems are weighing down the company’s share price. In that case, the company’s challenges may even cause it to stop or reduce its dividend payments. And before that happens, investors are likely to sell off the stock.

Fidelity Investments’ research has found that stocks that reduce or eliminate their dividends historically have underperformed the market by 20% to 25% during the year leading up to the cut.

Also consider the company’s payout ratio—the percent of its net income or free cash flow it pays in dividends. Low is usually good: A low ratio suggests the company may be able to sustain and possibly boost its payments in the future.

“As a rule of thumb, no matter what the payout ratio is, it is always important to stress test a company’s payout ratio at all points in the business cycle in order to carefully judge whether it will be able to maintain or increase its dividend,” says Adam Kramer, portfolio manager for the Fidelity Multi-Asset Income Fund.

“It all depends on the stability of the cash flows of a company, so it’s more about that than the level of payout. You want to test the company’s ability to pay and increase the dividend under different scenarios. In general, when the payout ratio is more than 50%, it’s a good reminder to always stress test that ratio,” Kramer explains.

Be sure to diversify as you build a portfolio of dividend-paying stocks. To help manage risk, invest across sectors rather than concentrating on those with relatively high dividends, such as consumer staples and energy.

References:

  1. https://www.fidelity.com/learning-center/trading-investing/inflation-and-dividend-stocks
  2. https://www.barrons.com/articles/quality-dividend-stocks-51639134001
  3. https://news.yahoo.com/inflation-pinch-challenges-biden-agenda-200620196.html

Past performance and dividend rates are historical and do not guarantee future results. Diversification and asset allocation do not ensure a profit or guarantee against loss. Investing in stock involves risks, including the loss of principal.

Historic Inflation Worries Americans

Posted on by

Worries by Americans over historic inflation level and higher retail prices are now larger than concerns about the coronavirus pandemic, according to recent polls from Monmouth and AP-NORC.

The U.S. consumer price index rose 0.8% in November from October. The Labor Department said consumer prices grew last month at an annual rate of 6.8%, which is the highest in 39 years since President Carter administration. The growth in prices were led by cars, food, gasoline, electricity and fuel oil.

As the bulk of Americans cite inflation and paying their bills as their top concerns, President Joe Biden’s job approval ratings fell to new lows with 69% disapproving of how he is handling inflation, according to an ABC/Ipsos poll.

Additionally, inflation concerns could potentially cost the President and Democrats’ their coveted social and environment legislation. It is believed that adding additional fiscal spending to already exploding government debt that adds juice to the economy might worsen inflation critics assert.

Most economists agree that the Build Back Better bill would add to inflationary pressures in the short run, however, they differed over its effects on inflation over the long term. Furthermore, most economists see inflation coming down sometime next year, but the debate is over how soon and by how much.

The bill will probably increase demand over the next few years, Harvard University professor Doug Elmendorf said. “That will tend to push up GDP and employment and inflation — which is not the policy impulse we need right now,” he added. Elmendorf served in the administration of former Democratic President Bill Clinton

References:

  1. https://www.barrons.com/articles/two-thirds-of-americans-polled-disapprove-of-how-biden-has-handled-inflation-51639331904
  2. https://www.bloomberg.com/news/articles/2021-11-17/top-economists-see-biden-s-spending-plan-adding-to-inflation

Retail Investor Inflation Strategy

Posted on by

Inflation refers to an aggregate increase in prices, commonly measured by the Consumer Price Index (CPI).

The federal government has pumped trillions of dollars into the economy through deficit spending and stimulus measures since the COVID-19 pandemic began. Meanwhile, the central bank of the United States, the Federal Reserve, has dropped interest rates to near zero and has committed to keeping them there through 2023.

The Federal Reserve’s mandates are to manage the money supply and set the federal funds interest rate in an attempt to keep inflation within a reasonable limit. This reasonable level of inflation is maintained because it encourages people to spend now, thereby promoting economic growth, rather than saving, as a dollar today is worth more than the same dollar tomorrow on average.

A constant level of inflation helps maintain price stability and is thought to maximize employment and economic well-being. Investors expect returns greater than this “reasonable,” average level of inflation, and workers expect wage increases to keep pace with the increasing cost of living.

The Consumer Price Index tracks prices for a broad range of products such as gasoline, healthcare, and groceries. The CPI rose 6.2% in October from the same month in 2020, the biggest spike since December 1990, according to the Labor Department.

High and variable inflation is considered bad for both investors and the wider U.S. economy because it can eat away at the value of financial assets denominated in the inflated currency, such as cash and bonds, particularly longer term bonds with more interest rate risk.

The prospect of variable or high inflation introduces uncertainty to both the economy and the stock market, which doesn’t really benefit anyone. This uncertainty or variable inflation distorts asset pricing and wages at different times. Prices also tend to rise faster and earlier than wages, potentially contributing to economic contraction and possible recession.

“Cash is not a safe investment, is not a safe place because it will be taxed by inflation.” Ray Dalio, Bridgewater Associates

In an inflationary environment, “cash is trash” since inflation operates like a tax which causes saved dollars lose value over time. High inflation rates decrease the purchasing power of money and it discourages people from holding cash assets and saving. “Cash is not a safe investment, is not a safe place because it will be taxed by inflation,” Bridgewater Associates’ Ray Dalio, the founder of the world’s biggest hedge fund said on CNBC Squawk Box.

Here are several suggestions for investors to consider to counter the risk and derisive impact of inflation on assets and the economy.

  • Consider buying equity stocks like bank stocks or consumer goods companies that will benefit from higher inflation or higher interest rates. Banking, consumer staples, energy, utility, and healthcare equities are likely to perform well. Banks would come out ahead if the Federal Reserve eventually raises interest rates to combat inflation, and banks’ spreads between loans and deposits widen. Also, look for companies that benefit from rising labor costs and be very attentive to how much you pay for (e.g., the intrinsic value) of risk assets.
  • Consider buying TIPS, or Treasury inflation-protected securities, which are a useful way to protect your investment in government bonds. These U.S. government bonds are indexed to inflation, so if inflation moves up, the effective interest rate paid on TIPS will too. TIPS bonds pay interest every six months, and they’re issued in maturities of 5, 10 and 30 years. Because they’re backed by the U.S. federal government, they’re considered among the safest investments in the world.
  • Avoid fixed income assets such as corporate and government non-TIP bonds. If rates rise sharply, their principal value will take a major hit. If rates climb, then certificates of deposit, fixed annuities, bonds, and bond funds purchased today will look less attractive in the future. Similarly, buying a lifetime income annuity is less enticing in an inflationary environment. The monthly check you get for the rest of your life will lose value more quickly with high inflation.
  • Keep the right sort of debt. Don’t pay off that home mortgage or real estate investment mortgages early, you’re better off paying it off over time with watered-down dollars. Homeowners carrying fixed mortgages with low interest rates are in a great position. It’s highly recommended to refinance your mortgage to lock in low rates. If inflation takes off, homes prices are likely to climb and your fixed monthly payment may appear like a real bargain in a few years.
  • Consider commodities or gold. Investing in oil, natural gas, wheat and corn can be good hedges against inflation. Gold has traditionally been a safe-haven asset for investors when inflation revs up or interest rates are very low. Gold tends to fare well when real interest rates – that is, the reported rate of interest minus the inflation rate – go into negative territory. Investors often view gold as a store of value during tough economic times.
  • Make essential purchases and charitable giving. If consumers expect to spend money on home goods, renovations, car repairs, or other products and services, they might be better off doing so now, before prices climb even higher.
  • Expect rising health costs. Health costs have risen faster than inflation for years. The pandemic, which is driving some health professionals out of the field, could accelerate that trend.

Keep in mind that inflation is always happening within the economy, but hopefully at a relatively low and steady rate, and kept under control by the Federal Reserve. Investors with a long time horizon, a high tolerance for risk, and a high allocation to stocks shouldn’t be worried about short-term inflation fears.

However, it’s perfectly suitable and even desirable for retirees, risk-averse investors, and those with a short time horizon to have some allocation to inflation-protected assets like TIPS, REITs and bank stocks.

Rising inflation is a big concern for investors, but it remains to be seen whether current high levels of inflation will persist or end up being due to “transitory” factors. Investors will likely come out ahead using assets like equity stocks, REITs, short-term nominal bonds, and TIPS to hedge against inflation.

References:

  1. https://www.barrons.com/articles/protect-finances-from-inflation-51637782342
  2. https://www.optimizedportfolio.com/inflation/
  3. https://www.bankrate.com/investing/inflation-hedges-to-protect-against-rising-prices/