Investment Considerations if You Feel Inflation is a Concern

It is an understatement to say the world has experienced a radical shift in capital markets. Since September of last year, there are more layers of information and opinions on the direction of the world than we’ve seen in decades. The internet and the media do not always make it easier, but I hope this regular contribution to In Business will help you sift through the noise and give you some perspective.

It’s no secret that U.S. Government and other world governments have injected huge sums of money into the global economy. It is relatively well-known that when governments print too much money, it inflates asset value. The question now is whether the amount the respective governments around the world have printed is enough to cause larger than expected inflation. Consideration of exposure to inflation protection becomes important.

(NOTE: As always this is not a recommendation to purchase, simply educational in nature.)

It should be said, that currently, as I write, inflation is not a near-term reality. In fact, it appears that the Consumer Price Index (CPI) will not rise enough this month to cause an increase in Social Security benefits. So on the surface, inflation appears tamed.

That said, it’s also important to know that government calculated inflation (CPI) is not usually well matched with those of you paying for college or those of you in retirement. Both groups often experience a higher cost of living adjustment due to education costs, health care, and discretionary spending.

But, if one thinks excess inflation is a threat long-term, where does one find inflation benefit?

There is no clear position on this, but the following asset classes may provide some benefit in inflationary environments:

  1. Short-term investment grade bonds. Short-term bonds (usually less than one to three years) reset their terms frequently at that current market interest rate. So in a rising interest rate environment due to inflation, or any other reason for that matter, captures those rising rates better than long-term bonds.

  2. Treasury Inflation Protected Securities (aka TIPS and I Bonds). TIPS are inflation-indexed bonds issued by the US Treasury. The bond’s principal value is adjusted to the CPI, which is the government’s measurement of inflation. So if CPI rises, the bond’s principal value will rise.
  3. Commodities. Commodities are the products that go into production of global economic output. They primarily include energy, agriculture, metals. In general, commodities tend follow CPI due to their demand on production. There is usually an additional risk premium for investing in their volatility and illiquidity. Investing in them is a risky proposition if done wrong because products are very sophisticated in their design. The product structure and trading of are beyond the understanding of most retail investors and quite frankly investment advisors alike. I generally think that commodity investing requires great caution since a misunderstanding of the product could well offset any potential benefit your receive as an inflation hedge. Furthermore (what is often not appreciated), at least 5% to 20% of companies in the major stock indexes around the globe consist of companies directly related to the production and or delivery of commodities, so it is theoretically arguable one receives exposure to commodities by investing in diversified global stocks.

  4. Stocks and Real Estate. Stocks and real estate appear to be a poor inflation hedge in the short-term, but by their very nature of incorporating cost of living adjustments in their pricing of services, rents, and/or products (along with rises in their underlying asset value due to inflation), they tend to have a long-term positive correlation to inflation. [When I discuss stocks or real estate, I am assuming index funds.]

It makes sense to avoid over-allocating to any one asset class. It is difficult to solely rely on a few investments that might hedge against inflation for your long-term welfare simply because, what if you are wrong? Nothing is certain, including whether excess inflation is on the horizon. Just like overallocating to stocks hurt many people through 2008, putting all your eggs in one "economic-forecasted basket" or another can potentially set you up for disaster if you’re wrong. Diversification of not just asset classes, but economic forecasts, is a prudent concept because it gives you exposure to all types of environments whether you think they’re going to occur or not.

Disclaimers:
This article contains the opinions of the author. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products or services described in this website or that of the author’s.

Mike Dubis does not guarantee the relevancy, appropriateness, or accuracy of any outside information or links. Mike Dubis does not render or offer to render personalized investment advice or financial planning advice through this medium. All references that might be made to an investment or portfolio’s performance are based on historical data and one should not assume that this performance will continue in the future.

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