It’s go-time for the Federal Reserve.
With inflation at a 40-year-high and up 8.5% in July over the past year according to the U.S. Bureau of Labor Statistics, the complacency that defined the Federal Reserve for most of 2021 is no longer an option. As the Fed gets more aggressive and tightens monetary policy in response to these pressures, a scramble is likely to ensue for investors hedging against inflation.
Across the curve, interest rates have risen in 2022, causing bond and stock prices to decline. Add in the poor performance of a slew of leading economic indicators as identified by the Economic Cycle Research Institute, and the prospect of a recession enters the conversation. There are reasons to believe that a technical recession may have already started.
To that end, it wouldn’t be a shock if the Fed continues to raise interest rates until the stock market and housing market break even further. According to the Federal Reserve Bank of St. Louis, it has already approved several interest rate increases after pinning the Federal Funds rate near zero from the beginning of the pandemic until early 2022, a move that has already resulted in the rise of borrowing and credit costs.
Inflation’s Influence on Investment Portfolios
If you’re hoping to shield your portfolio from inflation amid all this uncertainty, it helps to understand your time frame. In the short run, caution against a recession is probably warranted. Looking out over the next five years, though, I believe inflation should be your primary concern as an investor.
Inflation isn’t just affecting gas, bread, and milk prices — it’s affecting investment portfolios, too. Many stocks have tumbled, except for those with exposure to rising commodity, food and energy prices, which have done well in 2022. In fact, JPMorgan Chase says commodity prices could see an additional 40% upside as investors continue to be under-allocated in this area.
For investors trying to fortify their portfolios, it’s going to take a slight reimagination of diversification. In the past, experts advised their investors to enact a portfolio split of stocks and bonds, with the allocation to bonds increasing gradually as an investor approaches retirement age. But now? With both of those asset classes taking a hit (and nevertheless remaining significantly overvalued), broadening into tangible, real assets which are likely to perform better in an inflationary environment is well worth exploring.
Protecting Your Portfolio From Inflation
Finding the best investments for rising inflation can often mean looking for commodities with specific characteristics that will help them withstand an economic downturn. Sizing up where you are in the commodity cycle can enable you to see where things might be going down the road.
Here are a few strategies that might assist you in gaining commodities investment exposure that may work as an inflation hedge:
1. Buy gold as a hedge against accelerating inflation
There are many benefitswhen investing in gold — especially for risk-averse investors who need a potential safe haven amid economic uncertainty and market volatility.
These days, gold investment can take on several forms. It could mean buying actual gold bars or coins, or purchasing gold funds that offer liquid and low-cost ways to invest.
2. Get exposure to rising food and energy prices
People need to eat, drive to work, and heat their homes, regardless of what’s going on with the business cycle. You have to be picky, though, in selecting the right investment vehicles. This year, energy producers(source: Reuters) and fertilizer companies (source: MarketWatch) have significantly outperformed the rest of the market.
3. Determine if commodity prices are at or near a cyclical low
Since peaking in 2008, many commodities have been locked in a bear market. U.S. stocks have performed strongly in the interim, leading to commodities becoming extremely inexpensive relative to stocks.
When prices hit a low during a commodity cycle, capital-starved producers cut back on expenditures and reduce their supply. With diminished supply, prices eventually start to rise again; the opposite happens when prices rise high enough for long enough. Commodity producers expand capital, resulting in an eventual oversupply and declining prices.
4. Adjust your commodity exposure as needed
Your potential returns can depend significantly on your understanding of the commodity cycle. Right now, prices are far closer to a bottom than a top with many commodities — CNBC reported that the Invesco DB Base Metals Fund (DBB)fell to a 52-week low in July, for example — possibly indicating an attractive time to be invested.
Inflation is soaring, and nothing is off the table. There’s no better time to learn how to find appropriate commodities and commodity-producing companies that can assist in hedging against inflation and safeguarding your finances during this uncertain time.
The views are those of Adam Strauss as of the date of publication and are subject to change and to the disclaimer of Pekin Hardy Strauss Wealth Management.
