- Inflation, or the gradual increase in the price of goods and services over time, has a variety of positive and negative consequences.
- Inflation reduces purchasing power, or the amount of something that can be bought with money.
- Because inflation reduces the purchasing power of currency, customers are encouraged to spend and store up on products that depreciate more slowly.
What do you do with your money when prices rise?
As a result, we sought advice from experts on how consumers should approach investing and saving during this period of rising inflation.
Invest wisely in your company’s retirement plan as well as a brokerage account.
When it comes to inflation, what works?
The risk of inflation has grown. In developed markets, however, a sustained rise in inflation has been missing for the past three decades. As a result, investors confront the difficulty of having insufficient information about how to restructure their portfolios in the face of increased risk.
Rather than projecting when (or if) inflation would reach disruptive levels, we want to know what passive and dynamic assets have historically performed well (or poorly) in high and increasing inflation settings.
Why Does Inflation Matter for Asset Prices?
Unexpected inflation has a clear impact on Treasury bond prices. Their present values are based on an estimated real interest rate, inflation rate, and risk premium. If inflation rises faster than projected, the expected inflation embedded in the yield rises, and the bond price falls. Bonds with longer durations will be more vulnerable than those with shorter durations if the new level of predicted inflation is long-term. The risk premium may be affected by changes in inflation rate uncertainty.
Equities are more difficult to understand. First, higher and more volatile inflation exacerbates economic uncertainty, making it more difficult for businesses to plan, invest, grow, and enter into long-term contracts. Furthermore, while firms with market power can raise output prices to offset the impact of an inflation surprise, many companies can only pass on a portion of the increased raw material costs. As a result, margins are shrinking. Second, unanticipated inflation could signal future economic weakness. While short-term revenue increases may result from overheating, if inflation is followed by economic slowdown, predicted future cash flows will be reduced. Third, because depreciation is not adjusted to inflation, there is a tax impact for enterprises with substantial capital expenditures. Fourth, unexpected inflation may cause risk premiums (or discount rates) to rise, lowering equity prices. Finally, high-duration equities (particularly growth firms that promise dividends in the future) are highly susceptible to rising discount rates, similar to bond markets.
Commodities, like bonds, have an easy-to-understand inflation process. Commodities are frequently a source of inflation.
Defining Inflationary Regimes
We’re looking for situations in which both the speed and the acceleration of price increases are strong; in other words, when year-over-year inflation is high and rising. These types of places are the most vulnerable to the consequences we’ve discussed so far.
As a result, we define inflationary regimes as periods in which the year-on-year realised inflation rate exceeds 2%. Today, central banks around the world frequently aim this level, and it is seen as a psychologically significant threshold, even when not explicitly stated. The 2 percent target, for example, has been regarded as a “international standard” by James Bullard, President of the Federal Reserve Bank of St. Louis. We define’materially beyond 2%’ as a percentage increase of at least 5%. The eight US inflation regimes in grey in Exhibit 1 are the result of our definition. We use data from three continents dating back to 1926 to create a critical mass of evidence.
The red boxes at the bottom of the graph represent times when the US economy was in recession, as defined by the National Bureau of Economic Research.
Main Results
Exhibit 2 depicts a summary of how a variety of assets perform in each of the eight US inflation regimes. Readers are encouraged to study the whole research article, The Best Strategies for Inflationary Times, which can be downloaded for free, for a more extensive look at various assets and locations.
During periods of high inflation, stocks do poorly. On an annualized basis, the inflation adjusted or real return on equities is -7 percent.
During inflationary spikes, bond investors are penalized with a -5 percent annualised real return on the US 10-year Treasury bond. Bonds with extended maturities do even worse.
As a result, the 60-40 equity-bond portfolio underperforms during inflationary periods, returning only 6% real annualized.
Over the course of our 95-year study, commodities have outperformed passive strategies in terms of inflation. During our inflationary periods, they produced a 14 percent real annualised return, compared to just 1% in normal times. However, our analysis reveals that there is significant diversity among the various commodity components.
During inflationary periods, residential real estate in the United States has a modest negative annualised real return of -2 percent, while it has a positive annualised real return of +2 percent at other times. As a result, unlike commodities, the asset does not appear to fluctuate significantly during periods of inflation.
Inflationary periods have proven that collectibles, particularly art, wine, and stamps, have lived up to their reputation as a store of value. Art, wine, and stamps all have positive real returns, with art returning +7%, wine returning +5%, and stamps returning +9%.
Smaller companies suffer in inflationary environments when using active equity strategies. Inflationary periods result in a -4 percent annual premium for being long small companies and short large corporations, compared to a +1 percent premium in normal times. This is consistent with intuition. In order to reduce the costs of inflation, economies of scale are critical. During inflationary situations, the Profitability and Value components nearly hold their own. Given that higher-duration growth companies are frequently believed to be adversely affected by unforeseen inflation when discount rates rise, the Value performance may surprise some. Nonetheless, a Value long/short equity strategy outperforms a passive long-only equities strategy by a large margin. With real inflation regime performance of +8% on average, cross-sectional equity momentum performs strongly. While the average return difference is large, the difference is not statistically significant, as we show in the paper. Furthermore, this method has a high rate of turnover.
Active trend strategies in equities, bonds, foreign exchange, and commodities all did well. During the US inflationary regimes, a hypothetical “all-asset trend” portfolio generated a real CAGR of 25%.
Note: A summary table of real total returns to assets examined throughout this article, including the annualised return during inflationary, other, and all periods, as well as the annualised return during inflationary, other, and all periods (Exhibit 1). The approach is marked as active or passive in the first column by the letters ‘(A)’ or ‘(P)’, respectively. Returns in grey italics for energy and gold are spot returns for which we do not have futures data. These aren’t taken into account when calculating the combined regime.
International Inflation
We do a similar analysis for the UK and Japan as we did for the US and find that equities perform poorly during inflationary periods in their respective countries. Inflation times in the UK and Japan, for example, US equities achieve +6% and +9% real annualised returns, respectively, compared to -7 percent in the US. The findings also point to the advantages of international diversification. In the United Kingdom, for example, US and Japanese shares generate +6% and +9% real annualised returns during inflationary periods, respectively. Bonds definitely perform the worst during periods of high inflation in their own country.
Structural Change and the Rise of Cryptocurrencies
We must ask ourselves, like with any historical analysis, if this moment is different. Inflation spiked in the early 1970s, for example, due to an external event: the OPEC oil embargo. The US economy was heavily reliant on that source of oil at the time. Today, however, the United States is less reliant on foreign oil sources. Furthermore, while electric vehicles may not yet have critical mass, similar technical advancements in the future may make an increase in oil costs less likely to have the same inflationary effect. As a result, caution should be used while interpreting the results.
Given the fundamental evolution of the US economy, there are other considerations that must be carefully weighed. The United States was a manufacturing economy in the 1950s and 1960s. Manufacturing currently accounts for only 11% of GDP. The nature of businesses has shifted. Trade secrets, proprietary software, patented and unpatented R&D, client connections, and legal rights make up a large portion of the capital deployed. These may be more inflation-resistant.
Finally, another technological disruption is occurring in the shape of cryptocurrencies, such as bitcoin. Some have suggested that bitcoin be included in a diverse portfolio as an inflation hedge. However, due to the fact that bitcoin is unproven, with only eight years of high-quality data and no consistent inflation regime, prudence is advised. In addition, bitcoin is five times more volatile than the S&P 500 or gold. Because of its tremendous volatility, bitcoin may prove to be an unreliable hedge. Furthermore, there is mounting evidence that bitcoin is a speculative asset with a positive beta compared to the US stock market.
Conclusion
Our research spans almost a century. Because inflation spikes in industrialized nations have been uncommon in the last 30 years, the extended sample is especially noteworthy.
Some of our work just confirms what we already believe. When inflation rises, for example, Treasury bonds perform poorly. Commodities, which are frequently a source of inflation, perform well. However, we have some extra information to share. Commodities, for example, are a diversified group of assets, and the inflation hedging qualities of each commodity differ. Above all, we show that high and increasing inflation has traditionally been terrible news for stock investors and risk parity portfolios.
Active strategies are less well understood. We show that trend-following methods have performed particularly well during periods of high inflation. A handful of active equity factor strategies, such as a quality approach, also provide some risk mitigation during inflation spikes, according to our findings.
How do you protect yourself from inflation?
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.
Inflation favours whom?
- Inflation is defined as an increase in the price of goods and services that results in a decrease in the buying power of money.
- Depending on the conditions, inflation might benefit both borrowers and lenders.
- Prices can be directly affected by the money supply; prices may rise as the money supply rises, assuming no change in economic activity.
- Borrowers gain from inflation because they may repay lenders with money that is worth less than it was when they borrowed it.
- When prices rise as a result of inflation, demand for borrowing rises, resulting in higher interest rates, which benefit lenders.
Is gold a good inflation hedge?
- Gold is sometimes touted as a hedge against inflation, as its value rises when the dollar’s purchase power diminishes.
- Government bonds, on the other hand, are more secure and have been demonstrated to pay greater rates as inflation rises, and Treasury TIPS include built-in inflation protection.
- For most investors, ETFs that invest in gold while also holding Treasuries may be the best option.
What should you put your money into during a downturn?
During a recession, you might be tempted to sell all of your investments, but experts advise against doing so. When the rest of the economy is fragile, there are usually a few sectors that continue to grow and provide investors with consistent returns.
Consider investing in the healthcare, utilities, and consumer goods sectors if you wish to protect yourself in part with equities during a recession. Regardless of the health of the economy, people will continue to spend money on medical care, household items, electricity, and food. As a result, during busts, these stocks tend to fare well (and underperform during booms).
Is Bitcoin a safe haven from inflation?
But things aren’t going as planned. 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 ).
What is the safest investment?
Cash, Treasury bonds, money market funds, and gold are all examples of safe assets. Risk-free assets, such as sovereign debt instruments issued by governments of industrialized countries, are the safest assets.
Do banks fare well in times of inflation?
Inflation in the United States continues to rise, with the price index for American consumer spending (PCE index), the Fed’s preferred measure of inflation, rising at a rate of 4.2 percent in the year ended July, its highest level in over 30 years. Furthermore, core prices rose 3.6 percent, excluding volatile goods like food and energy. The figures come as a result of rising demand for products and services, which has outpaced supply systems’ ability to keep up following the Covid-19 lockdowns. Although the Fed is optimistic that inflation will fall, noting that it would likely lower its $120 billion in monthly asset purchases this year, the figure is still significantly above the Fed’s target of 2% inflation.
However, we believe that inflation will continue to be slightly higher than historical levels for some years. Personal savings, for example, have increased as a result of the epidemic, and the continuance of low interest rates over the next two years could result in higher prices for goods and services. Companies in the banking, insurance, consumer staples, and energy sectors are among the companies in our Inflation Stocks category that could stay steady or even benefit from high inflation. Compared to the S&P 500, which is up roughly 18% year to date, the theme has returned around 15%. Exxon Mobil has been the best performer in our topic, with a year-to-date gain of 28 percent. Chubb’s stock has also performed well this year, with a gain of roughly 20% thus far. Procter & Gamble, on the other hand, has been the worst performer, with its stock climbing only roughly 4% year to date.
Inflation in the United States surged to its highest level since 2008 in June, as the economy continues to recover from the Covid-19-related lockdowns. According to the Labor Department, the consumer price index increased by 5.4 percent year over year, while the core price index, which excludes food and energy, increased by 4.5 percent. Prices have risen as a result of increased demand for products and services, which has outpaced enterprises’ ability to meet it. Although supply-side bottlenecks should be resolved in the coming quarters, variables such as large stimulus spending, a jump in the US personal savings rate, and a continuance of the low-interest rate environment over the next two years could suggest inflation will remain high in the near future.
So, how should equities investors respond to the current inflationary climate? Companies in the banking, insurance, consumer staples, and energy sectors are among the companies in our Inflation Stocks category that could stay steady or even benefit from high inflation. Year-to-date, the theme has returned nearly 16%, roughly in line with the S&P 500. It has, however, underperformed since the end of 2019, remaining about flat in comparison to the S&P 500, which is up around 35%. Exxon Mobil, the world’s largest oil and gas company, has been the best performer in our topic, with a year-to-date gain of about 43%. Procter & Gamble, on the other hand, has underperformed, with its price holding approximately flat.
Inflation in the United States has been rising as a result of plentiful liquidity, skyrocketing demand following the Covid-19 lockdowns, and supply-side limitations. The Federal Reserve increased its inflation projections for 2021 on Wednesday, forecasting a 3.4 percent increase in personal consumption expenditures – its preferred inflation gauge – this year, a full percentage point more than its March projection of 2.4 percent. The central bank made no adjustments to its ambitious bond-buying program and said interest rates will remain near zero percent through 2023, while signaling two rate hikes.
So, how should stock investors respond to the current inflationary climate and the possibility of increased interest rates? Stocks in the banking, insurance, consumer staples, and energy sectors might stay constant or possibly gain from increasing inflation rates, according to our Inflation Stocks theme. The theme has outpaced the market, with a year-to-date return of almost 17% vs just over 13% for the S&P 500. It has, however, underperformed since the end of 2019, remaining about flat in comparison to the S&P 500, which is up almost 31%. Exxon Mobil, the world’s largest oil and gas company, has been the best performer in our subject, climbing 56 percent year to far. Procter & Gamble, on the other hand, has lagged the market this year, with its shares down approximately 5%.
Inflation has been rising, owing to central banks’ expansionary monetary policies, pent-up demand for commodities following the Coivd-19 lockdowns, company inventory replenishment or build-up, and major supply-side constraints. Now it appears that inflation is here to stay, with the 10-Year Breakeven Inflation rate, which represents predicted inflation rates over the next ten years, hovering around 2.4 percent, its highest level since 2013.
So, how should equities investors respond to the current inflationary climate? Stocks To Play Rising Inflation is a subject that contains stocks that could stay stable or possibly gain from higher inflation rates. The theme has outpaced the market, with a year-to-date return of almost 18% vs just over 12% for the S&P 500. However, it has underperformed since the end of 2019, returning only roughly 1% compared to 30% for the S&P 500. The theme consists primarily of stocks in the banking, insurance, consumer staples, and energy sectors, all of which are expected to gain from greater inflation in the long run. Metals, building materials, and electronics manufacturing have been eliminated because they performed exceptionally well during the initial reopening but appear to be nearing their peak. Here’s some more information on the stocks and sectors that make up our theme.
Banking Stocks: Banks profit from the net interest spread, which is the difference between the interest rates on deposits and the interest rates on loans they make. Higher inflation now often leads to higher interest rates, which can help banks increase their net interest revenue and earnings. Banks, on the other hand, will benefit from increased credit card spending by customers. Citigroup and U.S. Bank are two banks in our subject that have a stronger exposure to retail banking. Citigroup’s stock is up 26% year to date, while U.S. Bancorp is up 28%.
Insurance stocks: Underwriting surplus cash is often invested to create interest revenue by insurance companies. Inflationary pressures, which result in increased interest rates, can now aid boost their profits. Companies like The Travelers Companies and Chubb, who rely on investment income more than their peers in the insurance industry, should profit. This year, Travelers stock has increased by around 12%, while Chubb has increased by 8%.
Consumer staples: Consumer equities should be able to withstand increasing inflation. Because these enterprises deal with critical products, demand remains consistent, and they can pass on greater costs to customers. Our theme includes tobacco behemoth Altria Group, which is up 21% this year, food and beverage behemoth PepsiCo, which is almost flat, and consumer goods behemoth Procter & Gamble, which is down around 1%.
Oil and Gas: During periods of rising consumer prices, energy equities have performed admirably. While growing economies are good for oil demand and pricing, huge oil corporations have a lot of operating leverage, which allows them to make more money as revenue climbs. Exxon Mobil, which has gained a stunning 43 percent this year, and Chevron, which has risen roughly 23 percent, are two of our theme’s picks.
Heavy equipment manufacturers, electrical systems suppliers, automation solutions providers, and semiconductor fabrication equipment players are among the companies in our Capex Cycle Stocks category that stand to benefit from increased capital investment by businesses and the government.
What if you’d rather have a more well-balanced portfolio? Since the end of 2016, this high-quality portfolio has regularly outperformed the market.
What industries benefit from inflation?
Inflationary times tend to favor five sectors, according to Hartford Funds strategist Sean Markowicz: utilities, real estate investment trusts, energy, consumer staples, and healthcare.