2021 | How To Invest In Periods Of Increased Inflation

14 Dec 2021 | How To Invest In Periods Of Increased Inflation

Inflation has been in the headlines all year, and the Federal Reserve has consistently categorized it as “transitory” despite ongoing supply chain issues and continuing labor shortages driving both prices and wages upwards. Fed Chairman Powell has now retired the transitory language. This may seem like an obvious – and perhaps belated – decision, but the new more hawkish tone from the Fed will likely impact markets as investors digest the potential for an intensified tapering schedule and the potential for rates to go up sooner and higher. 

While inflation may be taking a bite out of your wallet for some time to come, as an investor, the question is about the future effects of a sustained inflationary period. Aligning a portfolio to capitalize on opportunities and avoid pitfalls is key in investing. But there’s still a lot of guesswork around the path of inflation and the Fed’s reaction to it, so what are the correct moves? 

We look at some history and dive into asset classes on both sides of the inflation fulcrum. We also provide our point of view on the current “crisis.” Spoiler alert: Investing is a long game, and this is just one inning. 

A Brief Examination of Inflation and Equity Returns

The CFA Institute examined inflation and stock market data from 1947 – 2021 and reports some illuminating findings. To set a baseline, inflation averaged 3.4% over the period. Over that same period, the average annual performance of the S&P 500 was 11.5%.¹ And don’t forget dividends – they’ve also grown at approximately 5% per year.²

Let’s not skip past this too quickly. Since 1947 inflation has averaged 3.4% while dividends, just the cash income you receive from owning 500 of the most successful businesses on earth, rose 5%! Throw in the annual 11.5% appreciation in the value of these great companies and you have a recipe for growing your income when while your cost of living rises. 

Why have the equities markets held up well in inflationary periods? Our belief is that stock prices are highly correlated to earnings. Companies that can maintain margins by passing increased costs on to consumers will be able to ride out inflationary periods. In some industries, the new prices will be normalized even when inflation subsides. 

Assets with a Natural Hedge

Certain assets have a natural hedge against inflation. Real estate prices have seen a steady upward curve that, even when it deviates, recovers quickly. The crash in real estate prices in 2008 was followed by a steady rise and a recovery in less than a decade. This was followed by the boom we are seeing today. In terms of numbers, home prices have appreciated on average 3.8% from 1990 to 2020, outpacing inflation. Looking forward, home prices are projected to increase 6.2% from 2021-2024, again outpacing inflation projections. 

Other real assets perform similarly. Allocating to real assets can act as a bond substitute in portfolios during inflationary periods as they can provide capital appreciation and income without the long duration exposure of bonds. HCO allocates to a Goldman Sachs Alternatives fund to provide exposure to domestic and foreign real estate, commodities and other real assets. 

Bonds and Cash Cost You Money

Briefly, let’s talk about the asset classes that do not do well in periods of rising inflation. With yields at a multi-decade low, finding income was a struggle with inflation at 2%. Inflation at 5% is essentially creating a negative return. 

Cash and short-term debt returns are similarly just a money sink. Earning 2% returns in the face of inflation that is likely to remain well above that could result in a multi-year loss of purchasing power. And that adds up. 

Time Horizon is Critical

Even without the transitory label, inflation is most likely not here to stay. Supply chain issues will resolve, and labor shortages are already sorting themselves out. Investing should be for the long term, and a portfolio that is constructed with a well-thought-out asset allocation should be able to weather short-term economic situations. The key is to remain invested and look at tactical adjustments, rather than making any big shifts. 

1Stock Market Returns Since 1947. officialdata.org.
2Carlson, Ben. The Simplest Asset to Hedge Against Inflation. March 11, 2021

General Disclosure. Readers of the information contained herein should be aware that any action taken by the viewer/reader based on this information is taken at their own risk. This information does not address individual situations and should not be construed or viewed as any type of individual or group recommendation. Be sure to first consult with a qualified financial adviser, tax professional, and/or legal counsel before implementing any securities, investments, or investment strategies discussed. The information contained herein is intended to be used for educational purposes only and is not exhaustive.  Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return.  If applicable, historical discussions and/or opinions are not predictive of future events.  The content is presented in good faith and has been drawn from sources believed to be reliable. 

Legal & Tax Notice. This information should not be construed as investment, tax, or legal advice and may not be relied on for the purpose of avoiding any federal tax penalty. This is neither a solicitation nor a recommendation to purchase or sell any investment or insurance product or service and should not be relied on as such.