If You Can’t Beat ‘em, Join ‘em
At this point it’s no surprise to investors that inflation is running hot. The September Consumer Price Index (CPI) reading showed a 5.4% year-over-year increase in prices and a 0.4% increase month-over-month.
When you peel back the onion in food prices (pun intended), you find that meats, poultry, and fish prices are up 10.4% year-over-year and eggs are up 12.6%. Gasoline prices are up 42% year-over-year. That hits the consumer pocketbook — and the value of the US dollar.
That’s the bad news. The good news is that’s just the spending side; next I’ll talk about the investing side. Specifically, what can we invest in that participates in inflation — joins it, so to speak — so that when your payments at the grocery store and gas pump are increasing, your investment account has a chance to grow with them.
Defense Wins Games, but Offense Gets the Glory
How do we play offense in the inflation game? For starters, invest in the very things that are increasing your expenses. A good example of this is commodities. Commodities include energy and agriculture — direct inputs to the inflation story that’s pressuring consumers. Commodities also include precious and industrial metals, which can have mixed results particularly in the case of gold (more on that later), but industrial metals are inputs into finished goods that can also hit the consumer pocketbook.
Over the period when CPI has come in above 4% (Apr. 2021 to the present), the Bloomberg Commodity Index returned 24.2% compared to the S&P 500 return of 13.8% and Nasdaq return of 14.2%.
Commodity prices can be volatile and require a careful look at risk tolerance and time horizon, but they can be useful tools for investors, especially in inflationary environments. Investing in a broad basket of commodities via ETFs or mutual funds helps diversify the exposure.
Don’t Forget the Little Ones
I admit, I have a soft spot for small-caps. Small businesses are the lifeblood of the American economy and small-cap stocks represent the purest form of growth opportunity; after all, a successful small-cap story is one that ends when the company grows into being a large-cap.
Small-caps can also be beneficial portions of a portfolio in inflationary environments. They tend to be more economically sensitive (read: cyclical or more volatile) than slow and steady large-caps, and if inflation is growing as an indication of economic expansion or strong demand, small-caps can do well in that environment.
Another aspect that protects them from the rising yields that typically accompany inflation is their sector make-up. The two largest sectors in the Russell 2000 are Health Care and Financials, vs. the two largest sectors in the S&P 500 of Technology and Communications. On a relative basis, rising yields would be expected to pressure Technology and help Financials. Hence, small-caps are more insulated from inflation simply by nature of the sector weights.
Good as Gold?
Gold has long been considered a store of value, or an asset that should hold its value in times when the US dollar was depreciating, but gold has provided lackluster (another pun intended) results of late.
Over the same period mentioned above (from April 2021 to the present), gold has returned only 4.5%, the US dollar was more or less flat over the period, and inflation rose every month.
This doesn’t suggest that gold is suddenly a bad investment, but rather that it doesn’t always work as we expect it to. This is also why a growing number of investors are turning to crypto assets as an option during inflationary periods.
Transitory Is a Long Time
Six months and counting of high inflation is something more than a flash in the pan. Investing in an environment like this requires you to have an opinion on the direction of inflation, and what I discussed above are some options for those who believe “transitory” inflation continues to drag on. Time will tell and monetary policy may change, but in the meantime, if you can’t beat ‘em, you may want to join ‘em.
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