Some of us are old enough to remember the double-digit inflation woes of the 70s. In 1974 President Gerald Ford declared inflation as “public enemy number one.” The public campaign, Whip Inflation Now, was launched with much ridicule and little success. It would take a decade, a brutal tight money policy and a recession before inflation returned to low single digits.
Our most recent decade has also been a difficult one, especially for savers and retirees, with interest rates at historic lows. One benefit has been historically low inflation.
Well, that could be changing.
When annualized, recent government numbers are pointing to inflation in the 3% range. While not the double-digit inflation rates of forty years ago, this is a disturbing upward trend. The core inflation calculation excludes housing, energy (gasoline) and food. I have yet to talk with a client who hasn’t already been dealing with rising prices for almost everything.
Further, the Federal Reserve has stated their target for inflation is a floor of 2%. This floor used to be their ceiling. In other words, the Fed wants to see inflation above 2%. They will likely get what they want. The long-term question is will they be able to contain inflation once it breaks out? I doubt it. Currently we would expect to see inflation for the next two to five years to be in the range of 3 – 5%. One of the primary sources of inflationary pressure will come from wages.
So what is an investor to do? Invest in assets that have historically been a good hedge against inflation.
One of our research sources has measured inflation sensitivity of the S&P 500 and its sectors. This table lists the ten major sectors:
Source: Haver Analytics, Bloomberg, Gluskin Sheff
Inflation beta is calculated using regression analysis; you can think of beta as the tendency of sector returns to respond to swings in inflation. A beta of 1 indicates that the sector’s performance will move in unison with the Consumer Price Index (CPI) or inflation. For example the S&P 500 Composite has an inflation beta of .56, which is our baseline. Any sector with a beta higher than .56 will do better than the general stock market, based on this analysis, during periods of higher than normal inflation. These include energy, materials, utilities and information technology. Why? Because these sectors have historically been able to pass on price increases better than other sectors.
In general, during periods of higher than average inflation, investments with hard assets do well. Hard assets have intrinsic value like oil, natural gas, precious metals, or land. Other subsectors that could do well with inflation include real estate (2.87), gold (2.73), and energy equipment (6.68). Subsectors that could underperform inflation are consumer services (-1.94), banks (-1.23), transportation (-.95) and pharmaceuticals (-.69).
So what does this mean? Tilting your investments toward hard assets can be an excellent hedge against inflation. And, as always, we recommend diversifying broadly. Please call your Wealth Manager if you have further questions.