HOW TO PROTECT PORTFOLIOS AGAINST INFLATION

A couple weeks ago, the Fed held a meeting where they let everyone know they were “thinking” about raising interest rates in 2023.

The Fed Chairman Jerome Powell himself summarized this non-announcement with this statement: “You can think of this meeting that we had as the ‘talking about talking about’ meeting.”

What does it all mean?

The Fed just admitted that it won’t act to lower inflation for the next two years. When I say, “won’t act,” what I mean is “cannot act.”

Given the size of the Federal debt, a rise in interest rates would be devastating to the government’s budget, triggering something akin to a death spiral. They know this, but they won’t come out and say it because the Fed doesn’t want to be a “shock to the system” (even their little non-announcement managed to rock the markets for a couple of days). They won’t take action until we reach the maximum point of pain.

 Inflation Is Not Going Anywhere

The Fed’s statements are a tacit admission that the higher inflation we’re experiencing is not transitory. If it were they would not “consider” raising rates in 2023. There would be no reason to.

Further, the inflation trade is impossible to kill. Just like mega-cap tech was impossible to kill for years. It just bounces back like a tennis ball. Tech had its day for almost a decade, now it is inflation’s turn.

 It is Worse Than You Think

Not many people know this, but the Fed regularly changes the criteria it uses to calculate inflation. Mostly this entails “removing” criteria vs. adding it. Some critics view these changes as a purposeful manipulation that allows the Fed to report a lower consumer-inflation rate. I’m not going to speak to that, but I will offer up this data:

If we calculated inflation the same way we did in 1990, the inflation rate would currently be 8%. If we calculated it the same way we did in 1980, it would be at 13%. The current US Fed calculation for inflation is at 5%.

 My Thesis

It will take a lot more than words to derail this inflationary impulse. It will take action. And put simply, the Fed is not willing to do anything more than hold “a meeting about a meeting.”

We can either play our cards right or we get run over by inflation.

How to Protect Portfolios Against inflation?

Inflation is a natural occurrence in an economy, and a disciplined investor can plan for it by cultivating asset classes that outperform the market during inflationary climates.

Shifting funds from bonds to stocks, especially preferred shares, is one strategy. On the other hand, Real estate usually performs well in inflationary climates; REITs are the most feasible way to invest. Adding global stocks or bonds to your portfolio also hedges your portfolio against domestic inflationary cycles. Another option is more exotic debt instruments, like bank loans.

My favorite financial instrument to fight inflation in order to not assume too much of extra investment risk is to add  TIPs (inflation-adjusted Treasury bonds) to the portfolio.

TIPS

TIPs stands for Treasury inflation-protected securities (TIPS) and are a type of Treasury security issued by the U.S. government. TIPS are indexed to inflation in order to protect investors from a decline in the purchasing power of their money. As inflation rises, TIPS adjust in price to maintain its real value.

The principal value of TIPS rises as inflation rises while the interest payment varies with the adjusted principal value of the bond. The principal amount is protected since investors will never receive less than the originally invested principal.

TIPS are issued with maturities of five, 10, and 30 years and are considered a low-risk investment because the U.S. government backs them. At maturity, TIPs return the adjusted principal or the original principal, whichever is greater.

TIPS can be purchased directly from the government through the Treasury-direct system, in $100 increments with a minimum investment of $100, and are available with 5-, 10-, and 30-year maturities.

Some investors prefer to get TIPS through a TIPS mutual fund or exchange-traded fund (ETF). Purchasing TIPS directly, however, allows investors to avoid the management fees associated with mutual funds.

Hence, it makes sense to me to add TIPs to the portfolio, especially  during inflationary economic cycles.

 

 

 

 

 

Disclosures: The material provided herein is for informational purposes only. It does not constitute an offer to sell or a solicitation of an offer to buy any interests in the EUR/USD or any other securities. This overview may include or be based in part on projections, valuations, estimates and other financial data supplied by third parties, which has not been verified by Pedro Ferreira. Any information regarding projected or estimated investment returns are estimates only and should not be considered indicative of the actual results that may be realized or predictive of the performance of the EUR/USD or any underlying security.  Further, Pedro Ferreira is not long or short in the currency pair. Past investment results of any underlying managers should not be viewed as indicative of future performance of the EUR/USD.

 

Menu
Ask a qestion