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The United States has been experiencing a deceptive calm regarding inflation for years. Historically, inflation, defined as the overall rise in prices, has averaged 3.3% annually since 1914. However, from 2009 to 2020, the consumer price index showed an average annual increase of only 2.1%. This subdued inflation period led many to become accustomed to prices that were significantly lower than the historical average, preparing the ground for the sharp increases seen in the wake of COVID-19.
To counter inflation, the most effective approach has been raising short-term interest rates. From 2009 to 2022, rates hovered near zero, aside from a brief increase in 2018. More recently, the Federal Reserve embarked on a vigorous campaign to hike rates, pushing them to over 5% within two and a half years. This strategy yielded some success: inflation rates fell from 8% in 2022 to 4.1% in 2023 and further to 2.9% last year. However, the Federal Reserve aims for a 2% target and has struggled to achieve it.
In a February article from The Economist, the publication warned that inflation is becoming increasingly concerning. President Trump, who was elected partly on the promise of stabilizing prices, has taken measures to address the issue. Alongside Elon Musk, he has attempted to cut government spending, but market prices are often sluggish to respond to fiscal policies unless they provoke extreme economic shifts—a strategy that may ultimately lead to a recession. Additionally, the administration’s plans to reduce energy costs through increased domestic oil drilling face obstacles, as global market forces largely dictate oil prices.
Inflationary Trends and Consumer Behavior
Amid rising concerns, consumers are starting to react. If they perceive inflation as a growing threat, their buying behaviors could further drive prices up. The latest University of Michigan Survey of Consumers revealed that inflation expectations for the next year surged from 3.3% to 4.3%—the highest of its kind since November 2023 and marking the second month of significant increases. This spike is partly attributed to the looming threat of higher tariffs, which would not only affect imported goods but also increase the costs of domestically produced items.
Strategies for Investment During Inflation
As the era of benign inflation may be approaching its end, managing an investment portfolio during heightened price levels becomes critical. An annual inflation rate of 3% may seem manageable; however, it suggests that a dollar’s purchasing power could decline by half in just 24 years. A 4% inflation rate shortens that timeline to 18 years. In this precarious landscape, are there viable pathways to safeguard investments?
The counterintuitive yet effective strategy is to invest in stocks. For instance, during the peak inflation years between 1977 and 1981, when the consumer price index surged at an average annual rate of 10%, the S&P 500 still managed an annualized return of 8%. This outstripped the disappointing returns from long-term U.S. Treasuries, which averaged declines of 1% annually when accounting for interest and price depreciation.
Businesses typically navigate rising costs by increasing their product prices, allowing stocks to maintain value during inflation. With inflation rates fluctuating around 5% from 2022 to 2024 alongside the Fed’s aggressive interest rate hikes, the S&P 500 has achieved around a 9% annualized return during this period.
In a piece I previously published nearly two decades ago, I advised investing in companies capable of elevating their prices in response to inflationary pressures. A prime example is Coca-Cola (KO, $71), whose share price has appreciated from $22 while offering an increased dividend yield of 2.9%. Coca-Cola remains a solid option—its unique product positioning makes competition infeasible. Other worthy candidates include tech companies with subscription-based revenue models; leading names like Apple (AAPL, $242) and Alphabet (GOOGL, $170) fit this bill.
Another stock worth considering is Public Storage (PSA, $304), a real estate investment trust specializing in storage solutions. Its pricing power remains intact, as relocating stored goods to avoid a modest price hike poses significant inconveniences. Public Storage has shown an impressive annualized return of 11.7% over the past five years.
Additionally, franchise companies—ranging from advertising agencies to insurance firms—tend to perform reasonably during inflationary times, despite facing current market upheaval. Stocks like Live Nation Entertainment (LYV, $143) and Chubb (CB, $285) represent good opportunities within this sector.
Investing in Commodities
Commodity prices usually rise during inflation, but entering leveraged futures contracts can be fraught with risks—high transaction costs and potential losses can severely impact your capital. My preference leans away from investing in physical commodities like lumber and gold, opting instead to focus on human capital and innovation.
A prudent alternative for accessing commodity markets is investing in natural-resource funds, which leverage both commodity price increases and human ingenuity. One option is Vanguard Materials (VAW, $197), with an attractive expense ratio of 0.09%. Linde (LIN, $467), a leading supplier of industrial gases, forms a significant part of this fund, which has seen its stock price double in under five years.
Another viable choice is the iShares North American Natural Resources (IGE, $44) ETF, which includes a substantial focus on oil and gas stocks like EOG Resources (EOG, $127) and notable companies such as CRH (CRH, $103), a key player in the building materials sector based in Ireland.
Considering Treasury Inflation-Protected Securities (TIPS)
TIPS, or Treasury inflation-protected securities, offer a guaranteed real interest rate alongside adjustments linked to CPI changes. In February, 30-year TIPS were auctioned with a real rate of approximately 2.4%, marking the highest level since 2001. If inflation remains around 3% until maturity, the annual return would exceed 5%.
However, TIPS’ market can be extremely volatile. During periods of heightened inflation, it’s advisable to avoid long-term bonds and bond funds except for those with shorter maturities. The reason is that rising rates diminish the value of previously acquired bonds with lower fixed rates.
Focusing on stocks often proves to be a more fruitful strategy, even if those returns may not match the high peaks seen during stable economic conditions. One effective approach to weathering inflation is to hold a diversified investment portfolio, including options like SPDR Dow Jones Industrial Average (DIA, $438), an ETF recognized as Diamonds. The Dow’s composition features companies well-equipped to navigate inflationary pressures, including stalwarts such as Nike (NKE, $79) and insurance leader Travelers (TRV, $258). Moreover, the Dow leans toward value stocks, generally better positioned during inflationary periods compared to their growth-oriented counterparts.
While inflation poses challenges for investors, it need not become a formidable foe. A steady hand and a diversified investment strategy can help navigate this uncertain financial landscape.
Source
www.kiplinger.com