Last week Consumer Price Index (CPI) rose to over 9%, the highest level in 40 years! Excluding food and energy, the rate was 5%. For the average consumer, it means they will be spending more every month on goods. Many investors have been asking how to profit from inflation in the long term?
The best way to profit from inflation is to invest in assets that will appreciate as the currency value decreases. Certain assets like real estate, commodities, and consumer products will likely hold their value in rising inflation and also increase in value. Chosen wisely, an inflationary economic environment could lead to generating greater returns from the portfolio.
Who is to blame for the inflation? Milton Friedman says the government. Friedman explains below –
Someone once said whenever there is a crisis, there is an opportunity. As a Capitalist and don’t agree with the current monetary policy of the government and Federal Reserve. Unfortunately, I can’t change or stop them. They will continue to print money. Thus I might as well try and profit from inflation.
Inflation is all around us. Many people will point to the rising real estate prices as a supply issue, but I tend to think part of its inflation. I recently went to the store, and the foam plates I buy are up over 20%.
In order for people to profit from inflation long term, investors need to know what is inflation, what is causing its rise, how it is measured, and then opportunities.
This article aims to cover the basics of inflation, rising inflation, measuring inflation, sectors, and how to take advantage of rising inflation for the long term. As a bonus, we have included inflation stock picks and an exchange-traded fund (ETF). Please feel free to scroll down how to profit from specific assets: Real Estate, Commodities & Precious Metals, Cryptocurrencies, Bonds & TIPS, Inflation Stocks To Buy
Inflation Expectations Rise – What is causing the rising inflation?
I agree with Friedman and believe the government is 100% responsible for rising inflation. That being said, I think we have four things that are causing inflation to rise:
- Supply Chains Are Broken: Nearly everything from propane tanks to chicken wings is experiencing some kind of supply issue.
- Pandemic Ending: A large amount of the country is back to normal and eager to dine out, buy real estate, travel, and get out.
- Stimulus Checks: Uncle Sam’s stimulus checks have cause people to buy cars, houses, and other things.
- Gov’t Spending: The government is printing money faster than ever before. This is likely to be the biggest and most dangerous part of increasing inflation.
The stock market is very fearful of inflation and has been extremely volatile lately. However, as a Capitalist and someone that has been watching the market for over 25 years, I am looking for ways to on how to profit from inflation. Inflation in the simplest form is the rise in consumer prices and goods. Most of the time, we have some level of inflation.
Despite the political and ideological biases on both sides, December saw consumer inflation continue to rise in line with consensus expectations. Core CPI increased by 0.55% mom which raised the YoY rate from 4.93% to 5.45%, the highest level since 1991. The headline CPI rose 0.47% mom, as energy prices fell by 0.4% mom, and food prices rose 0.5% mom. Headline % Yoy rose to 7.04 percent from 6.81% — the highest level since 1982, when ET was the dominant box office star.
The inflation we are seeing right now is causing a massive rise in prices and is also one of the reasons why the real estate market is climbing to new highs. If left unchecked, this could lead to out-of-control inflation which is called hyperinflation.
BofA points out that supply issues in the auto industry continue. Wholesale prices indicate further upside in used vehicle prices in the months ahead. Core goods components, other than autos, gained broadly as apparel rose another 1.7% mom and household furnishings/supplies rose 1.3% mom. Meanwhile, education/communication commodities slipped for the third consecutive month, this time by 0.4%. According to BofA the breadth and depth of gains in goods reflect both global supply chain disruptions as well as the pull-forward during the holiday shopping season which saw earlier discounts in October.
Many consumers are very worried that they will no longer be able to pay for goods and services with their current level of resources of high inflation. Groceries for example are currently on pace to increase over 10% for the year. In a rising inflationary environment, consumers will need to dig deeper to buy the same or buy less with the same amount of resources.
Like most other things in the world, there are many sides to the picture. The ‘more’ that consumers are spending is going to the seller of these products and services (Read more below about “Consumer Price Index”). However, rising inflation could be an opportunity for investors to profit with the right investments.
What is inflation?
In economics, inflation is a measure of the rate at which the general level of prices for goods and services is rising. When your paycheck doesn’t go up as quickly as it should, it means that prices are going up faster than your income. This could indicate an inflation problem if there aren’t any other factors to explain why you’re not getting ahead financially. High inflation can also drive down the value of one’s savings and investment assets, like stocks or bonds.
If you have been paying $2 for a loaf of bread and now pay $2.40 for the same loaf, you are experiencing inflation. Generally speaking, rising prices are an example of inflation. In most economies, there is usually some inflation, but sudden rising prices for goods and services signal a high inflation rate.
From a consumer’s perspective, inflation is bad news. It also tends to lower the purchasing power of the currency and increased interest rates. If your national economy continues to experience high inflation, in the future, you will be able to exchange your dollars for fewer Euros than today if the Eurozone experiences lower inflation, other things staying the same.
While exact cause and effect may not be possible to establish, there are many contributing factors. It could be as simple as a demand-supply gap which could create price inflation. At other times, the cost of inputs going up, like wages and cost of input materials, are likely contributors. There will be further underlying factors for the inflation of prices of those input factors as well.
Rising Interest Rates Ahead?
In addition to having prices rise, one of the other key things of rising inflation is rising interest rates. Currently, the Federal Reserve Bank is holding down interest rates by pumping in funds into the system. During inflationary periods in the US (1946–48, 1950–51, 1969–71, 1973–82, and 2008) interest rates shot up.
How do you measure and express inflation?
Inflation is a numerical indicator, measured as a factor of increase over a defined base, and expressed as a percentage. The 40-cent increase in the price of bread represents a 20% increase in the price of bread over a base of $2. If that was the only product being bought, it would mean inflation of 20%.
Purchasing power is another way of expressing the same phenomenon. If you only had $2 to buy the bread and could not spend the additional 40 cents, you will be able to buy only a part of that loaf. Hence, your purchasing power has reduced to that extent.
What are the methods of measuring inflation?
Economic theory deems it necessary to have a certain amount of inflation as it is believed to promote spending that fuels economic growth. Monetary authorities and Central Banks work at policies that create inflation but keep it within defined boundaries.
Commonly used measures of inflation are:
What is Consumer Price Index (CPI)
The Consumer Price Index (CPI) is a measure of the average change in prices over time in a fixed market. The index measures price changes for goods and services, such as food, transportation, clothing, and medical care. CPI measures inflation from a consumer’s perspective and takes into account the prices of a standardized basket of finished, ready for consumption, goods. It is measured and reported monthly by the Bureau of Labor Statistics (BLS) in the US.
How is CPI calculated?
The Consumer price index (CPI) measures the percentage change in the average price of all items available to consume or provide service at some time “t” during the measuring period. The period used to calculate CPI is a “base year”. This means that after every year, the yearly average of all prices changes by this amount. In some years there may be noticeable differences between CPI and other economic data. This is because other data only go back one year. In that year, you cannot compare results from other data sources with prices in the base year.
The CPI is calculated by taking a weighted average of prices of all items available to consume. This price index does not include the services of doctors, lawyers, or accountants (no services at all), and it does not reflect quality changes (product substitution), product additions, and product deletions; these are sources of error. Another reason why this index is not a good measure of inflation is that it does not take into account changes in the quality of items. For example, if you buy a computer that provides twice the memory you used to have, it will be counted as a price decrease even though technically, your purchasing power has increased. In this case, you would need to buy two computers instead of one.
What is the Production Price Index (PPI)
The Production Price Index (PPI) is a measure of the change in prices of raw materials used to produce manufactured goods. The PPI measures the prices for key ‘inputs’ and is more volatile than the CPI since it takes into account a wider variety of inputs. PPI accounts for changes in transportation costs, duties, taxes, subsidies, and other government transfers that often fall on the final consumer as well. However, PPI does not include some items that the CPI includes.
What is the Wholesale Price Index (WPI)
The Wholesale Price Index (WPI) is a trade-weighted index of wholesale prices. Like PPIs, WPI measures the price changes in the production of goods. WPI differs from PPIs because it only includes the change in prices from a fixed market.
How does inflation benefit the rich?
Inflation historically benefits the rich because they have more hard assets like real estate that will hold their value while the currency decreases. People with lower income generally have a hard time because wages generally do not keep up for inflation and they have little assets that appreciate. The key thing to remember is that inflation affects currency and many assets maintain their value.
What investments do well in inflation?
A very common question we are getting is, “What investments do well in inflation.” The short answer is any hard asset like real estate, commodities, precious metals, and some stocks. The reason for this is because the value of the currency is going down almost in an inverse correlation pattern to real assets.
In my reading of Milton Friedman, an economist who Nobel Memorial Prize in Economic Sciences, he suggested people buy as many hard assets and even acquire debt during inflation because the value of the assets will actually increase because the currency went down.
Investing for inflation is a strategy that has its upsides as well as downsides. While it could help in preserving the value of your portfolio or real estate in the short run as well as enhance income, you may get distracted from your long term investment goals. You could also go overweight in certain asset classes which, as earlier mentioned, might be contrary to your long-term strategy.
Of course, it might trigger a re-evaluation of your portfolio and consequent redistribution which could be a beneficial impact of an event like inflation. If it had not happened, you may not have re-evaluated your goals and strategies.
At the very least your want your investments to outpace the consumer price index (CPI) and rising interest rates. Rising interest rates will have an effect on companies differently as some companies carry more or less debt. If the Federal Reserve raises rates, this could also affect many financial stocks.
Hence, your investment strategy might be inflation-influenced, but guarding against it becoming inflation obsessed is advised. The overall investment objectives and timelines should continue to guide your strategies.
Lastly, past performance in investments is no guarantee for the future. Tried and trusted strategies can fail and unheralded assets can deliver surprising returns.
Imagine if you could have bought $1000 dollars worth of bread in 1945 and then sold it in 2018 for $32000. Obviously, you can’t store bread that long, but you could buy other assets. There could be several positive outcomes of inflation, from an investor’s perspective. We will look at a few asset classes.
Historically considered to be a good hedge against inflation, real estate tends to retain its relative value thanks to inflation, leading to an increase in the resale value over a period. While rental is a good reason too, but that remains good whether there is inflation or not.
I think house prices will outpace inflation if we look the 1970s numbers. From 1968 to 1981, existing house prices went up +251% with a net change of +34%. Interesting enough, new home prices net increase was +19%. I think this was due to the increased costs of goods.
Indirect investments in real estate, such as through Real Estate Investment Trusts (REITs) should also be included in this category. We do remain very cautious about real estate because it is in a bubble and there has been stopping of foreclosures and evictions.
Many experts have said real estate is in a bubble and about to blow, so we recommend being cautious before making any purchases into real estate. A report last week from Morgan Stanley was very bullish despite the bubble on real estate and thinks prices could continue into 2023. It did, however, urge caution.
Commodities & Precious Metals
Gold has been an investor’s haven in times of crises, an investment of last resort. When investors are buffeted by adverse winds, such as those during inflationary times, turning to physical assets seems to be a self-preservation instinct, which drives the move to precious metals, among which gold has always stood out. For this article, we decided to break real estate into its own section.
In 1971 gold traded at $35 an ounce, but was up to $850 by 1980. This is a 2300% gain! There was a huge amount of volatility and sideways movement for all commodities during the 1970s, but they all generally a upward trend.
Now one does not even need to buy physical gold coins or bars and hide them under the carpet or bury them in the backyard. Investing in gold-specific Exchange Traded Funds (ETFs) and stocks of gold-mining corporations are additional avenues available to investors.
Commodities investing is not limited to precious metals. There are several other types of commodities that could work just as well in this respect such as oil, and agricultural products such as soybeans, orange juice, and cotton.
Oil, for instance, flows through the entire economy. Modern economies rely on the transportation of consumables across vast distances. This cannot be done without oil to run those vehicles, whether aircraft, ships, or trucks. During times of rising prices, oil is a favorite of many investors as its price tends to mirror inflation.
Commodity futures and swap contracts could be suitable instruments, especially for experienced investors, to take positions in commodities as an inflationary hedge, assuming not many would like to keep barrels of sunflower oil or gunny bags full of corn in their living rooms.
Several years ago I a friend was telling me about “Bitcoin” and how it was going to counter the dollar’s value losses due to inflation. Although I thought it was a great idea at the time, I thought the government would shut it down. Well, since then Bitcoin and cryptocurrencies have risen to new highs.
Due to the newness of the sector, it is really hard to know how they will perform. Theoretically, Bitcoin should do well. Some even argue that the recent rise of Bitcoin to the dollar is due to inflation. Others would say it would be the availability of people to purchase and trade Bitcoin is the cause for the increased value.
We think cryptocurrencies could be a good hedge against inflation. However, there is a good chance of new regulations and government oversight that could also destroy the sector. We recommend looking at Ethereum or Monero as they both have unique advantages.
Bonds & TIPS
Personally, I stay away from most debt instruments during rising inflation. However, some people would make the recommendation to invest in what are known as Treasury Inflation Protected Securities (TIPS) in the US and are inflation-indexed bonds pegged to the CPI which are opposite to 10YR that pays a fixed rate of interest. Otherwise, investing in bonds would be a losing proposition as interest rates tend to rise during high inflation rate times pushing down Bond yields.
Typically, the base value of a TIPS Bond rises with CPI which pushes up the payout since interest paid is calculated on the base value. There are a variety of ways in which these Bonds can be accessed by investors, such as through mutual funds and ETFs. Direct investment is also possible through the Treasury via your brokerage account.
Bonds that pay a fixed rate are at risk of losing their value if the Federal Reserve raises rates. Long term bonds will get hurt the most in a rising interest rate environment. I would also include mortgage securities in the same bucket and caution investors due to rising interest rates.
If you have the appetite, even junk bonds could become attractive at such times. Junk bonds, being high-yield debt instruments, rise in value with a rise in inflation. However, investors must understand that as interest rates rise, current bond values will decrease. Tough riskier, the risk-return trade-off offered by these Bonds becomes more attractive when yields in other investments start shrinking.
Inflation Stocks To Buy
While stocks have long been a favorite of investors, being a portfolio approach, you may need to pick your basket with care. Underlining your basket with stocks of companies that are able to pass on their cost to clients should be preferred. High dividend-paying stocks have historically lost value during such periods and should be avoided. Fixed rate blue-chip dividend stocks should do well or fair better than smaller companies.
In addition to looking at stocks, investors should consider an exchange traded fund (ETF) as a way to protect against an inflationary environment. This creates great diversification. The critical thing is that investors must have long term perspective.
For those that don’t remember, the worst stock performance of the 1970s came when inflation increased rapidly and double to about 6% from 1972 to 1973. The market dropped 40%! However, it came back by 1980 leaving investors flat for most of the decade.
Smart investors looking at the past would move away from growth stocks and more toward consumer stables and basic materials stocks. We have seen a strong trend of increasing prices of these sectors. Consumers may not buy a new car, but they will eat. We also think there is a good chance of vice stocks performing well.
Looking for a list of inflation stocks? Here are 3 free inflation stock picks.