Bitcoin has lost 18 percent of its value against the dollar since inflation began to pick up in the spring of 2021, lagging other risk assets like the S&P 500 stock index (up 8%) and classic inflation hedges like gold (up 7 percent ). Bitcoin and the S&P 500 stock index are both down 8% so far in 2022, while gold is up 3%.
Does crypto provide inflation protection?
Cryptocurrency’s demise demonstrates that it is not an inflation hedge. Cryptocurrency may not be a good hedge against 7% inflation. Everything in finance is being upended by new technologies, from saving to trading to making payments.
Is inflation a factor in cryptocurrency?
Many cryptocurrency supporters consider it to be a digital equivalent of the US dollar, which it is in some ways.
Although not every coffee shop accepts Bitcoin or Ethereum, crypto is becoming more popular as a means of payment. Several well-known merchants (and well-known e-tailers) now take bitcoin, and the number of firms taking digital currencies is certain to increase.
When the value of a dollar erodes over time due to inflation, people often hunt for assets that can consistently outperform inflation. Some experts believe that crypto’s huge moves in a year like 2021 could serve that function. Many investors already do this with gold, commodities, and other types of investments. Rather than investing in traditional and alternative investments to grow and store wealth, an investor can buy cryptocurrencies in the hopes that its value will rise, making it less sensitive to currency swings.
Big fluctuations in crypto mean it lacks the steadiness needed to outpace inflation, as we’ve learned over the last several months. For example, Bitcoin’s value plummeted in 2021, just as consumer prices began to rise, and it plummeted again towards the end of 2021, which has continued into 2022.
This also indicates that Bitcoin is now untrustworthy as a daily money. When the value of a digital coin fluctuates by 10% in a couple of days, it’s difficult to envision it as a reliable tender for the average individual to use to make purchases. Because of its volatility, it is dangerous not only as a currency, but also as an investment asset class.
What are some excellent inflation hedges?
ETFs and mutual funds are two of the most straightforward ways to diversify investments into international markets. When compared to acquiring a portfolio of American Depositary Receipts (ADRs) or foreign stocks, these funds are a low-cost method to invest. If you’re already invested in S&P 500 index funds, you might want to diversify your holdings with an international index fund.
Why is Bitcoin not a good inflation hedge?
There are disagreeing (or, at the very least, opposing) viewpoints from people like:
- Morningstar. The investment ratings agency stated in a review of the evolving stages of inflation in the United States, “The claim that hedges against inflation is based on a small amount of evidence. While it’s plausible to believe that bitcoin will aid in the survival of a portfolio against inflation’s ravages, this is far from certain.”
- Bank of America is a financial institution based in the United States. The bank discovered that “The justification for holding Bitcoin is not diversification, falling volatility, or inflation protection, but rather simple price appreciation,” he continued, “since commodities and even equities give better correlations to inflation.”
Are cryptocurrencies immune to economic downturns?
Cryptocurrencies have not been around during previous recessions, but their decentralized structure could make them an effective instrument for recession hedging. Gold, cash, and real estate are all conventional ways to protect against the risk of a recession.
How will you protect yourself from inflation in 2022?
During the epidemic, there was a surge in demand for products and labor, resulting in the fastest rate of consumer price and wage inflation since the early 1990s. As the pandemic passes and spending moves toward services rather than products, we believe inflation will reduce due to greater labor supply. In the end, it should not jeopardize our base case scenario, which predicts a significantly more vibrant cycle in the 2020s than we experienced in the 2010s.
However, both prices and salaries are expected to rise at a pretty rapid pace. We believe there are three ways for investors to navigate this climate.
Look to real estate for inflation protection
Because leases are regularly reset higher, real estate investors often profit from a natural inflation hedge. Furthermore, we believe the residential and industrial real estate sectors will benefit from strong structural tailwinds. Following the global financial crisis, chronic underbuilding (compared to trend) resulted in a housing shortage in the United States. Workers’ labor is in high demand, and earnings are rising, ensuring that housing remains cheap even as home prices rise. Migration enabled by remote work is also offering opportunities.
The global trend toward e-commerce will demand additional warehouses, storage, and logistics in the industrial sector. The need for further investment is highlighted by problems in the global supply chain that became apparent in 2021. We’re also seeing an increase in demand for life science research facilities. While we prefer to invest in real estate through private markets, publicly traded real estate investment trusts (REITs) have outperformed other equities sectors during periods of rising inflation. In a nutshell, real estate is our favourite option to invest in a higher-inflation climate.
Rely on equities, especially cyclical ones, to drive capital appreciation.
While economists dispute the complexities of inflation, the fundamental principles underlying the current phase appear to be clear: Strong demand and economic growth are driving inflation. Because corporate earnings are also good in inflationary settings, equities tend to do well. We anticipate that stocks of companies that are more closely linked to economic activity and interest rates will likely outperform. Bank stock valuations, for example, have generally been linked to inflation forecasts. In cyclical industries like industrials and commodities, companies with pricing power could see strong revenue increases. Stocks that do well when growth and inflation are rare (think the digital economy) may, on the other hand, be at more risk. In our opinion, you should maintain a fair balance between the two categories, and expect a hard environment for fixed income portfolios as interest rates climb.
Avoid excess cash, and consider borrowing.
In our Long-Term Capital Market Assumptions, 80 percent of the assets we consider have a higher predicted return than inflation. Investing surplus cash in a portfolio that meets your goals and time horizon is the simplest approach to protect purchasing power. In the current environment, borrowing could also be prudent. Interest rates remain low, particularly when compared to inflation. A mortgage is a straightforward approach to profit from a healthy home market. If the Federal Reserve reacts to rising inflation by boosting interest rates, borrowing expenses may become less appealing.
Key takeaways
Higher inflation is likely to persist through 2022, but it does not have to be a reason for alarm. Investors can create a portfolio that considers inflation risks and attempts to manage them. While excess cash appears unappealing, relying on equities rather than fixed income and focusing on cyclical sectors and real estate could prove to be profitable strategies. Meanwhile, while policy interest rates are still low, borrowing and settling existing liabilities may be prudent.
In the context of your individual circumstances and aspirations, your J.P. Morgan team can provide you with more information on how the present environment is influencing risk and return possibilities.
Are bonds an effective inflation hedge?
If rising inflation persists, it will almost certainly lead to higher interest rates, therefore investors should think about how to effectively position their portfolios if this happens. Despite enormous budget deficits and cheap interest rates, the economy spent much of the 2010s without high sustained inflation.
If you expect inflation to continue, it may be a good time to borrow, as long as you can avoid being directly exposed to it. What is the explanation for this? You’re effectively repaying your loan with cheaper dollars in the future if you borrow at a fixed interest rate. It gets even better if you use certain types of debt to invest in assets like real estate that are anticipated to appreciate over time.
Here are some of the best inflation hedges you may use to reduce the impact of inflation.
TIPS
TIPS, or Treasury inflation-protected securities, are a good strategy to preserve your government bond investment if inflation is expected to accelerate. TIPS are U.S. government bonds that are indexed to inflation, which means that if inflation rises (or falls), so will the effective interest rate paid on them.
TIPS bonds are issued in maturities of 5, 10, and 30 years and pay interest every six months. They’re considered one of the safest investments in the world because they’re backed by the US federal government (just like other government debt).
Floating-rate bonds
Bonds typically have a fixed payment for the duration of the bond, making them vulnerable to inflation on the broad side. A floating rate bond, on the other hand, can help to reduce this effect by increasing the dividend in response to increases in interest rates induced by rising inflation.
ETFs or mutual funds, which often possess a diverse range of such bonds, are one way to purchase them. You’ll gain some diversity in addition to inflation protection, which means your portfolio may benefit from lower risk.
Are bonds beneficial during periods of inflation?
Maintaining cash in a CD or savings account is akin to keeping money in short-term bonds. Your funds are secure and easily accessible.
In addition, if rising inflation leads to increased interest rates, short-term bonds will fare better than long-term bonds. As a result, Lassus advises sticking to short- to intermediate-term bonds and avoiding anything long-term focused.
“Make sure your bonds or bond funds are shorter term,” she advises, “since they will be less affected if interest rates rise quickly.”
“Short-term bonds can also be reinvested at greater interest rates as they mature,” Arnott says.