Hi All,
I am heading out to a conference later this week and one of the topics of discussion will be the outlook for inflation and how to protect your portfolio.
As we all saw earlier this month, the February Y.O.Y. inflation numbers did not look good, coming in at + 7.90%. What is troubling is that the inflation data seems to be broadening out beyond just a couple of key sectors.
On a year-over-year basis, goods inflation rose by 13%, the most since 1980. That included the largest-ever annual increase in the prices of new cars and trucks up 12.4% and 41.2% respectively. Services costs increased 4.8% from a year ago, the biggest advance since 1991.
The table below from the Bureau of Labor Statistics (BLS) shows that 6 out of 12 categories for headline CPI are showing double digit gains on a Y.O.Y basis (right column). The other 6 categories have increased between 6% - 9%.
From the BLS,
“The food at home index rose 8.6% over the last 12 months, the largest 12-month increase since the period ending April 1981. The index for meats, poultry, fish, and eggs increased 13.0% over the last year as the index for beef rose 16.2%. The other major grocery store food group indexes also rose over the past year, with increases ranging from 5.2% (dairy and related products) to 8.2% (other food at home).
The index for food away from home rose 6.8% over the last year, the largest 12-month increase since December 1981. The index for limited service meals rose 8.0% over the last 12 months, and the index for full service meals rose 7.5%. The index for food at employee sites and schools, in contrast, declined 40.7% over the past 12 months, reflecting widespread free lunch programs.
The energy index rose 25.6% over the past 12 months with all major energy component indexes increasing. The index for gasoline rose 38.0% over the last year and the index for natural gas rose 23.8%. The index for electricity rose 9.0% for the 12 months ending February”.
Clearly inflation is here, the question is for how long?
The FED is in a difficult position. During the last rate hike cycle that began in 2015 and lasted until 2019, the FED increased rates from 0.00% to 2.50%. The 2.50% level proved to be the ceiling as the economy began to show cracks and rates were lowered back down to 1.50% (pre-pandemic). Then in March 2020 the pandemic hit and we were back to 0.00% (ZIRP).
To be fair, government policies have fueled higher inflation. David Schassler of VanEck points out that M2 grew 30% since March 2020. In layman’s terms, the supply of money in the US economy increased 30% over the last 24 months!
Check out Schassler’s report here for lots of cool graphs.
Another policy contributing to higher inflation is the massive transfer payments from the Treasury to citizens, whether the funds were needed or not. Certainly many folks were in a difficult spot and needed an infusion from the government to keep the lights on and food on the table. But, a lot of people that collected checks from the government didn’t necessarily need the money.
Either way, consumer spending on goods and services is way up.
The invasion of Ukraine creates a whole new set of problems for reigning in inflation. Unfortunately Russia is a serious player in the global commodity markets and is a top 3 producer in many critical commodities (see below). The sanctions being imposed on Russia will create new inflation catalyst, so don’t expect inflation to subside anytime soon.
PORTFOLIOS:
So what can we do to mitigate the damage caused by inflation to our investment portfolios? Having exposure to hard assets including realestate, commodities and gold will help mitigate risk.
As you can see from the chart above, equities can strugle in a high inflation enviroment in terms of real returns (returns after inflation) But, equity exposure the energy and materials sectors generally do well in an inflationary environment and are still pretty cheap on a relative basis (see below courtesy of VanEck).
In the fixed income space short duration, high yielding securities are your best bet, perhaps with a splash of TIPs.
For more specific advice on weightings, check out the videos below.
VIDEOS / PODCAST:
VanEck How to Invest for Inflation Protection March 9, 2022: This is a short video with David Schassler, Portfolio Manager and Head of Quantitative Investment Solutions at VanEck, in the video he discusses the path forward for investors and the portfolio allocations that may provide protection against inflation (7 minutes).
VanEck Real Inflation Risk Requires Real Assets March 8, 2022: This is a longer video (40 minutes) with David Schassler to examine the current inflation drivers and how to best adapt allocations using real assets, including gold, commodities, and natural resources equities, to offset its potentially detrimental effects.
CONFERENCES:
NEPC PUBLIC FUNDS WORKSHOP, Tempe Arizona, March 29-30: This is a great event for pension fund staff and trustees to get an update on NEPC’s capital markets assumptions and and how clients are positioning their portfolios I will be part of a panel discussion titled “everything you would ever wanted to know about crypto currencies”.
PANTERA BLOCKCHAIN SUMMIT, San Francisco California, April 4-5: A day of panel discussions centered around DeFi, Web3, Regulation, The Metaverse, and more.
TEXAS SOCIETY of CERTIFIED PUBLIC ACCOUNTANTS, Austin Texas, April 21: I will be presenting on alternative investments as a diversifier to improve long-term risk adjusted returns.
MILKEN GLOBAL CONFERENCE, Beverly Hills California, May 2-4: The conference will examine various disruptions, lessons learned, and innovations brought on by the global pandemic as well as other health, social and economic issues.
STATE ASSOCIATION OF COUNTY RETIREMENT SYSTEMS (SACRS), Rancho Mirage California May 11-12: I will be part of a panel discussing digital assets and how they fit into institutional portfolios
I hope that you enjoy the letter as much as I enjoyed writing it and please feel free to share the links with friends and associates. If you are interested in startups and are an accredited investor you can join over 750 other backers that follow my AngelList syndicate here.
Stay safe and stay well. Sean Bill / MacroCrunch / Twitter