You probably are familiar with the term the Great Recession, but the “Great Inflation” is not as widely known. That refers to a period in the 1970s and early 1980s that saw inflation surge as high as 14 percent — ouch.
Current levels of inflation are relatively low, but that may change. Is your portfolio ready?
Some inflation is considered good, as it demonstrates underlying demand in the economy or more dollars chasing goods and services. In recent years, central banks around the globe have been trying mightily to stimulate inflation through various means, including quantitative easing and zero — or even negative — interest rates.
There are some signs that it’s working.
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“Year-over-year inflation numbers are all moving higher,” says Bryce Doty, senior fixed income manager at Sit Investment Associates in Minneapolis.
The May core consumer price index is up 2.2 percent. An increase in the shelter index, or rent prices, and a jump in the medical care service index contributed to the recent gains.
Doty points to several factors that suggest inflation could increase in the second half of 2016, including the jump in crude oil prices, accelerating wages and rising real estate prices.
“Single family and multi-family housing markets have been strong with both home prices and rents accelerating. Rental rates are an important component of core CPI. Owners’ equivalent rent rose 3.3 percent year over year and is the highest since the end of the financial crisis,” Doty says.
Since the global financial crisis, some economists have warned that attempts by the Federal Reserve to stimulate economic growth through quantitative easing measures could ultimately stoke inflation. This hasn’t erupted yet, but remains something to monitor.
“The longer central banks continue to use quantitative easing and other attempts to stimulate global growth, the more the risks of future inflation rise,” says Chris Zaccarrelli, chief investment officer for Cornerstone Financial Network. “It looks like inflation won’t be a problem globally this year, but it’s something we’re watching closely and we believe it will be a much larger factor in the years to come.”
In general, rapidly rising inflation is bad for stock market investors, Zaccarrelli says. “Inflation increases input costs faster than companies can raise the price of their products and it hurts earnings,” he says.
However, not all sectors are affected equally.
“Companies in the energy and materials sectors are most likely to respond positively to rising inflation,” Zaccarrelli says, “while those in consumer staples and other sectors that aren’t able to raise the price of their products quickly enough can be negatively impacted.
Rising inflation hurts bond investors in two ways, Zaccarrelli says.
“The first is that the fixed payment they are receiving has its purchasing power eroded as the general level of prices rises while their income doesn’t,” he says. “The second way it hurts bond investors is that central banks and or markets generally adjust to rising price levels by raising interest rates, which leads to an instant devaluation of the price of the bonds.”
Current bond market levels are not showing worries about inflation. But, analysts say that could reflect safe-haven concerns ahead of this week’s U.K. referendum on leaving the European Union, widely known as the Brexit vote.
Now may be a good time to consider if your portfolio is properly protected against a growing inflation risk.
“Inflation is going to be something that may gradually affect your portfolio,” says Craig J. Ferrantino, president of the independent financial planning firm Craig James Financial Services. “Whether that effect is positive or negative depends on the actions you begin to take. You want to be diligent about your investments knowing that change is afoot.”
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Here are four potential investment winners in a rising inflation environment.
Real estate. “Real estate is a natural inflation hedge that also tends to pay decent current income. A basket of REITs is generally a good addition to any portfolio, and now more than ever,” says Charles Sizemore, founder of Sizemore Capital Management.
One option for investors includes the Vanguard REIT ETF (ticker: VNQ). Sizemore calls it “a very solid option. It gives broad diversification to the REIT sector and has the lowest fees of any of its competitors.”
Commodities. Oil, gold and other products such as food and housing are likely to increase as inflation increases, Zaccarrelli says. “Look at ETFs that cover the energy sector or the home-building sector (which) are attractive in an environment with increasing inflation. Additionally, identifying companies that pay a dividend on their stock that is higher than the rate on their bonds is another way to seek income that is likely to increase as price levels increase,” Zaccarrelli says.
Treasury inflation-protected securities. TIPS are issued in terms of five, 10 and 30 years. These are securities investors can buy directly from the U.S. Treasury or through a bank or broker. The principal of a TIPS increases with inflation and pays interest twice a year.
“I feel TIPS … would be an investment for investors to consider if they are looking for an idea on the safer side,” Ferrantino says.
Investors can also access exposure to TIPS through an exchange-traded fund: iShares TIPS Bond ETF (TIP). “We like the ETF TIP given our view on inflation and how undervalued TIP’S are relative to traditional Treasurys,” Doty says.
The Sit Rising Rate ETF (RISE). This is a favorite pick, Doty says. Its negative 10-year duration is linked primarily to two- and five-year treasury yields.
“RISE is expected to appreciate roughly 10 percent if yields rise 1 percent. While Brexit and the Fed-is-dead mentality weighs on yields today, in the end, inflation always trumps the Fed and RISE is prepared to profit when yields begin to rationally reflect inflation expectations,” he says.
Sizemore says the best advice for investors now may be to stay flexible.
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“Be willing to invest in new ways you’ve never invested before,” he says. “We’re in uncharted territory. We’ve never had negative interest rates, nor have we had this level of central bank manipulation. We don’t know how this story ends, so we need to stay nimble and flexible.”
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4 Ways Investors Can Protect Against Rising Inflation originally appeared on usnews.com
