West News Wire: Inflation doesn’t care who you are. It’s pinching everyone’s wallet, and it’s squeezing practically every retirement plan investment.
Stocks have been volatile this year, with the S&P 500 plunging more than 10% from its highs, owing to concerns about inflation. Bond prices have plummeted as well. Prior to gold’s recent increase as a result of Russia’s invasion of Ukraine, the metal with a reputation as an inflation hedge had just finished its worst year in the last six, despite inflation reaching unprecedented levels.
The truth is that there is no perfect strategy for investing in a high-inflation environment. However, many on Wall Street believe that certain segments of the market will hold up better than others, if not outright.
It marks a turnaround for investors, who got used to years of low inflation that didn’t dent their earnings very much, said Gargi Pal Chaudhuri, head of iShares Investment Strategy, Americas, at investment giant BlackRock. “Going forward, I think that level that used to be 1.5% to 2% is likely to be closer to 3%, and you need to start thinking about where you can move,” she said.
That doesn’t mean investors need to start day-trading their retirement accounts, after a long-term buy-and-hold strategy worked so well for years. But they may want to shade their portfolios in certain directions, including parts of the stock and bond markets that can actually benefit from inflation.
Bonds are supposed to be the safe part of anyone’s portfolio. But when inflation is high, the fixed payments they’ll make in future years will buy less stuff.
Expectations keep rising for how many times the Federal Reserve will hike interest rates this year to slow inflation, with prices for consumers 7.5% higher in January than a year earlier. When rates rise, newly issued bonds pay more, and the bonds already sitting in bond funds’ portfolios suddenly look less attractive, forcing down their prices. Vanguard’s Total Bond Market Index fund has already lost 4.2% this year, as of Thursday.
It may be a shock to lose money on bonds, but investors shouldn’t abandon them, Chaudhuri said.
“At the end of the day, the bonds are still giving you that ballast,” she said. “They are still that ultimate diversifier that will still work in an environment where stocks are going down significantly.”
Some commodities have performed well during high-inflation periods over prior decades. Surprisingly, gold isn’t always one of them.
Its price fell about 4% last year, even when inflation was accelerating quickly. And it yo-yoed through early 2022, before worries about Russian aggression against Ukraine sent it surging.
“Once inflation is already high, gold’s hedging power is not as strong” against inflation, said Rich Weiss, chief investment officer, multi-asset strategies, at American Century Investments.
That may be because the Fed’s usual medicine for high inflation higher interest rates can hurt gold. When bonds are paying more in interest, investors may be less willing to park their money in gold, which pays them nothing.
Other commodities have had stronger track records. “That’s almost tautological,” Weiss said, because rising prices for oil and other commodities are often some of the main reasons for inflation spikes.
Some on Wall Street suggest considering investments that track a broad range of commodities, such as some specialty ETFs, though they can have higher expenses than stock and bond funds.
If prices for oil and other commodities are rising with inflation, so likely will the prospects for the companies that are producing them. That’s why several strategists suggest focusing on energy stocks in particular.
Within the S&P 500, energy stocks have surged more than 22% this year, when the overall index is down a little more than 8%.
Other areas of the market that look relatively less expensive are also likely better bets in a world with high inflation and rising rates, say strategists at UBS Global Wealth Management. Stocks that look expensive, such as big tech stocks following their strong years long run aided by low interest rates, are likely to get hit harder.
Financial stocks haven’t been hit as hard as the rest of the market this year because higher long-term rates are raising expectations for bigger profits from making loans. But even there, risk remains. Banks tend to make the most money when they can borrow money cheaply at short-term rates and lend it out at more expensive long-term rates. If that gap closes, they may be set for pain.
Stocks from emerging markets have also shown well in past instances of high inflation, in part because many of those companies are producers of commodities. They also look cheaper than the U.S. stock market, which has been the world’s dominant force for years.
“COVID has prevented us from traveling overseas physically,” American Century’s Weiss said, “but you definitely want to start traveling overseas with your assets.”