đź’¨Inflation Might not Go as Quickly as it Came! Here’s Why and How You Can Position Your Portfolio

I dunno about you, but I feel like inflation almost came out of nowhere. We went from cruising along with stupidly low levels of inflation and super-low rates (they were slashed to 0.1% here in the UK in March 2020!) and suddenly we find ourselves sitting in this painful mess of double-digit inflation. Sorry, near-to-double-digit inflation. We went from 10.something% to 9.9%. What a joy!

Mortgage rates are spiking that 6% is the new 2.5% which is producing peak-pain while energy bills and all the rest of it are getting ahead of themselves. Totally inconceivable a year or two ago! But somehow, here we are anyway. 

If inflation kinda happened so quickly, surely it’s gonna go down just as quickly? Ha, I wish. And while that is a (teensy) probability it’s probably not gonna happen. In which case we’ve gotta make sure that both our finances and portfolio are properly prepared – and armed.

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There’s honestly nothing worse than being caught off-guard and being taken by surprise. We investors (and markets, obvs) hate surprises. When there’s peak uncertainty that’s when markets get super rattled. Brexit, covid, and now this. Not sure what to call it. 2022 madness seems to be fitting! 

Here’s a fabulous description of inflation: it’s just like toothpaste. Once it’s out, it’s pretty impossible to get it back in. I once had the fun task of squirting out way too much attempting to put the excess back in. I failed. Leaving a sticky mess behind. 

Why inflation is becoming sticker by the second! 

Prices are rising by the most in 4 decades so let’s look under the bonnet to understand why prices are rising so much so quickly. Let’s start with inputs costs: when they rise, it puts pressure on companies to raise their prices and while some can get away with absorbing the cost, most can’t. And the biggest input if you like are workers. And the labour market is the tightest it’s been for years and years. 

In the UK look at the number of strikes from rail strikes to postal services and so on. Basically, workers are carrying so much more power now than ever before and it’s putting pressure on wages. And when wages rise, companies have no choice but to push up the price of their end product so that they don’t go outa pocket! This is the same problem that the US is facing, it’s not just us Brits! 

So now you see how the days of uber-low rates are over since central banks have to keep rates off the ground to tame inflation – or at least look like they’re trying. 

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We’re getting older. And it’s gonna cost

Now let’s add demographics to the mix. Face it, our population is ageing. The developed world is not as young as it used to be and this will mean the labour pool is much smaller. Back to the basics: when supply (workers) falls, prices (wages) go up. Not exactly a recipe for low inflation. And to make things a little spicier, globalisation is going backwards. Hiring cheap labour from abroad might be a thing of the past thanks to frictions between the US and China and the war in Ukraine. 

It’s going to be very, very hard to undo all that. And it almost becomes a self-fullilling prophecy: the more we expect prices to go up the more we’ll buy things now rather than wait for an even higher price which in turn pushes things higher! 

What can we learn from the 70s?

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So, to know how to position our money for soggy stagnation (the stinky combo of high inflation and low growth) we’ve gotta time travel back to the 70s. This period was when central banks lost control of the money supply (sound familiar?!) and there were also 2 big oil price shocks which only added more fuel to the fire. Literally! 

Before we look at where you might want to allocate your capital to, let’s look what you should avoid and that is bonds. With stagflation bonds become a little useless at hedging against recession and volatility. For young investors with plenty of time on their hands, there are better places to allocate your capital but this year they’re really not living up to anyone’s expectations.

Bonds are down 13.4% this year. So much for being a portfolio diversifier! Sure, they’re not down as much as equities but that’s quite a hit for “safe” assets! High inflation erodes their future value so why would you want to own depreciate things. Nah. I expect this bond bear market to continue for some time. 

Okay, so what assets actually did well (or lost the least value!) during the stagflationary period of the 1970s and how we can use that to our advantage! 

Commodities: physical and digital

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Gold did very, vey well. So much so that practically popped. In 1971 gold was trading at $35. By the end of that decade, it reached a cool $850. That’s a 2,300 percent gain in the 1970s! But what goes up, must come down. And it soon fell rapidly after 1979.

But other commodities which also enjoyed a surge in value ended up losing less of their value in the 1980s than gold did. Commodities like oil & gas, metals and so on is probably where you’ll want a nice exposure to during stagflationary times but obviously there’s no guarantee and as we’ve seen, past performance really is no indicator of future performance. 

I plan to increase my exposure to Bitcoin for the simple reason being that there are only 21m coins in existence. There’s no central bank that can tamper with that number, debasing its value, and no one entity that controls it. As inflation ravages our purchasing power (just look at Venezuela!), more and more individuals will turn to things that can hold their stores of value.

And for me, that looks to be Bitcoin. You have to know your risk tolerance and your appetite for such volatile assets but before you make up your mind (or have it made up for you!) it’s worth doing some digging. You might surprise yourself! The key is to keep an open mind. A really open one.

Yielding assets  

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During the 70s, commercial and residential property bubbles in the UK burst in the mid-1970s but prices then recovered. Real assets proved to a calm in the storm. Real state tends to hold up pretty well during inflationary times least of all because rents tend to rise along with inflation and the capital value of a property will also rise.

You’ve gotta take into account rising interest rates (making mortgages more expensive to service) hence the recent downturn in some REITs (real estate investment trusts) but many have been oversold here and are well-capitalised. So these are worth a look into.

Turning to yielding stocks can shelter some of your income. Companies, and by extension sectors, which benefit from higher interest rates are also worth looking into. Think banks, insurance and even auto companies as they can pass on these costs by whopper rates on their financing plans! REITs fit into this category as well, btw.

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Small caps, emerging markets

Interestingly, small caps and emerging markets can also be areas of refuge. Small caps are an interesting inflation hedge: since these businesses tend to be pretty niche ones they can get away with raising prices more than others which is why they can hold up during inflation. But small caps have recently been hammered. Take the FTSE Small Cap Index, it’s down 20% year-to-date while US Small Caps are down a similar amount.

You’ve gotta ask yourself whether the bad news is already priced in or whether there’s further nastiness to come. Either way, they’re also worth looking to as a long-term hold as they’re excellent sources of growth but that’s a personal thing and you might want to avoid them altogether! Again, this will depend on your overall risk tolerance which will be different for everyone.

Onto emerging markets. Countries like China and Japan are doing the exact opposite of what the West is. They’re busy lowering rates while we’re raising ’em. This could prove to be a useful source of portfolio diversification. But tread carefully as the strong dollar causes ever more havoc.

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Investing isn’t always easy and you won’t ever know for certain which areas will do (relatively!) well. You’ve gotta have some faith, a dollop of luck and nerves of steel. Spread your money across many different areas, holding your assets for a while, and that should see you through the storm. However bad that might get.

But you don’t want to miss out on the market’s best days. Hang on and don’t sell as that will cost you dearly. So dollar-cost average and invest over a long period of time. If your time horizon is <5 years, I’d say stay away from markets as it’s for this exact reason that you might be investing during a particular rocky time and your money won’t have enough time to recover.

So here are just some things to think about. But as ever don’t have too much exposure to any one sector. If you’ve got a lot of time ahead of you, it will still make sense to arm your portfolio with some growth but capital preservation and the need for some income as we enter this uncertain period is no bad move.

Good luck!

Disclaimer: This blog is not investment or financial advice. It is my opinion only. This blog is not a personal recommendation to buy/sell any security, or to adopt any such investment strategy. Always do your own research before you commit to any investment.

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