Three Assets to Consider if Inflation Monster Attacks

If the value of the money you hold is falling, then its monster inflation is eating away your ability to purchase products and services. Inflation represents the rate at which prices of most goods and services increase over a given period, lowering purchasing power or you buy less for the same amount of money held before.

That means, with the rise in inflation, the money you save or invest from your regular income diminishes over time, emerging as a primary concern for investors and their portfolios. So, it is always wise to choose assets that earn you more than the inflation rate or at least keep pace with rising prices.

Here are three asset classes that will help you beat the inflation heat or at best help you hedge the growing risk at a time when global inflationary pressures are looming as major economies recover from the COVID-19 pandemic.

COMMODITIES

Commodities are the real assets; they tend to behave differently compared to bonds and stocks in a changing economic condition. For instance, commodities are the first to benefit from rising inflation as demand for goods and services increases, thereby, pushing the prices of commodities used to produce those goods and services. Commodities can range from a raw material used to produce consumer goods to crude oil, including gasoline or petrol, or metals such as gold, silver, copper, and aluminum.

Empirically, commodities have proved to be a rewarding investment in the long run and displayed their abilities to endure high inflation spikes, making it an efficient hedge against inflationary pressures. Most economists expect commodities to thrive over the coming year as fresh COVID-19 cases subsided by late April due to the lockdown measures and the vaccination program, helping major economies pick up growth due to recovery in demand, thereby, pushing prices higher.

“This environment is a sweet spot for commodities, as inflation is starting to rise, but monetary policy is not getting tighter for quite some time, leading to a virtuous cycle of higher commodity prices, stronger EM growth and rising global inflation, reinforcing the same positive feedback loop between commodities and the USD that happened in every other structural bull market, like the 1970s or 2000s,” noted economists at Goldman Sachs.

The New York City-based investment bank forecasts commodities to rise further 13.5% over the next six months due to the decline in infections and the countries easing some of the restrictions on movement and economic activity. The Bank expects Brent oil, the international benchmark, to hit $80 per barrel and West Texas Intermediate (WTI) to hit $77 per barrel over the six months. Goldman Sachs also forecasts gold prices to hit $2,000 an ounce over the next six months and copper price $11,000 per ton in 12-month time.

So, we think that a “supercycle” for commodities is around the corner which makes them a very attractive investment option now.

US TREASURY INFLATION-PROTECTED SECURITIES (TIPS)

Most bonds are not a true perfect hedge against inflation as coupon payments are generally fixed throughout their years- or decades-long lifespans. Regardless of the price movement in the secondary market, coupon payments remain the same or generally not adjusted.

But Treasury Inflation-Protected Securities (TIPS) are one of the only true real assets available that are indexed to inflation. That means the principal of a TIPS goes up with inflation and decreases with deflation, helping combat inflation risk that erodes the yield on fixed-rate bonds. It is worth noting that, TIPS are also highly safe as it is issued by the U.S. government, making it a better option for a conservative investor who aims for absolute safety. Although the real rate of return is guaranteed, TIPS could underperform compared to standard U.S. Treasuries during a period of low inflation.

“The view on US Treasuries is cautious and we prefer Treasury Inflation-Protected Securities (TIPS) as an attractive diversifier and agency mortgages, which may offer opportunities as the Fed remains active,” noted Eric Brard, head of fixed income at Europe’s largest asset manager Amundi.

So, you can consider adding TIPS to your portfolio if you are looking for protection against inflation and any risk of credit default.

VALUE STOCKS

Rising prices of goods and services can translate into more profit for companies, which in turn increases the stock price. In high inflation periods, value stocks are widely expected to perform better than growth stocks, which mostly outperform during the low inflation phase. Of course, there is no guarantee that most stocks will outperform at the time of rising inflation but empirically, returns from value stocks have comfortably beaten inflation over the years.

Investors have favored growth stocks, especially technology, over value stocks for more than a decade due to falling interest rates. That helped growth stocks soar but with the recent surge in bond yields on higher inflation expectations, the FANG and other high-growth stocks look more vulnerable to a heavy sell-off than before.

“The explosion of monetary and fiscal stimulus has put the U.S. and world economies on a much faster growth track than that prevailing before the pandemic. This means the near-term rise in nominal GDP, corporate revenues, and household incomes is much bigger. This stronger near-term rise in growth is evident in the rotation away from long-duration growth stocks toward short-duration cyclical and value stocks that benefit more from the big boost to the outlook for the next few years,” noted Niladri Mukherjee, head of CIO Portfolio Strategy at Merrill Lynch.

Investors should evaluate their portfolio and see whether any investment in growth stocks are highly overvalued and try to balance out that risk. But growth firms that have regularly given high profitability with attractive valuations and sustainable business models would be better positioned to fight the inflation monster.