Three Key Reasons This Isnt The 1970s For The Economy
First, organic demand growth in terms of new disposable income is not going back to the 1970s. In the United States, the share of new workers, as measured by the 15-34 year age group, peaked in 1980 alongside inflation. That age group is an important driver of growth and inflation because, on average, they make several critical first-time purchases, buying their first car, having their first child and buying their first house, often on credit. Separately, another source of new disposable income, female participation in the labor force, had its greatest gain in the 1970s. So, while demand is certainly exceptional today (as we described in our previous commentary, Halloween and Christmas for Markets, these 1970s-era drivers were one-time phenomena.
The Best Ways To Invest When Inflation Takes Off
- Inflation surged more in June than it has in more than 10 years, and the news has investors worried.
- Rising prices can erode a portfolio’s profit.
- But there are some moves investors can take to shield their money from inflation and even take advantage of the environment, experts say.
Inflation surged more in June than it has in more than 10 years, and the news has investors worried.
That’s because rising prices can erode a portfolio’s profit. Most simply, as the cost of living swells, your returns don’t go as far.
That’s a particularly tough challenge for retirees, who may rely mostly on their investment yields to pay their bills, whereas younger people still have a salary. And then there’s the fact that inflation can cause the Federal Reserve to raise interest rates, which tends to be bad for equities.
“In general, inflation is usually negative for stocks,” said Amy Arnott, a portfolio strategist at Morningstar.
What Assets Do Well During Stagflation
What Investments Do Well During Stagflation? The mainstream media is focused on comparing the 2020 economy to the Great Recession and Great Depression. Its because these events sound so great that they become the focal point of everyones economic fears. The reality is were more likely to face a long period of stagflation. Understanding what that means and which assets do well in stagflation are the keys to outlasting this rough market.
Consumers should treat their finances like a small business. That involves keeping track of operational and overhead costs, along with tracking revenue versus spending. Increased prices and decreased wages equate to razor-thin margins. The working class is presumably in a bind, and the governments economic stimulus is unlikely to change that.
If youre looking for a path forward in this economy, this guide is for you. Well explain what stagflation means, how its caused, and which assets perform well under these economic conditions. Lets start by defining the term, so you understand what were talking about.
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What To Avoid Before Inflation
In a word: bonds.
Just as you want to borrow money at fixed interest rates during inflation, you dont want to lend money at a fixed interest. Thats effectively what bonds are: loans at fixed interest rates, whether to governments or corporations.
If you buy a bond paying 4% per year, and inflation surges at 5%, you effectively lose 1% in real dollars each year. And that means no one will want to buy them, either.
Remember, when interest rates and bond yields rise, the price of existing bonds goes down. So when interest rates surge to manage runaway inflation, your existing bonds that pay low interest plummet in value on the secondary market.
These fixed-income investments might seem safe on the surface, but they lose their value quickly when inflation spikes.
If you worry that inflation lurks around the corner, talk to your investment advisor about potentially reducing your asset allocations in the bond market.
Inflation Hedges: Broad Basket
How They Can Help: Inflation hedges are investments whose values go up when higher inflation comes on line. These investments can be further subdivided into two groups: those that aim to reflect inflation broadly, as measured by the Consumer Price Index, and those that reflect higher prices in a smaller basket, such as commodities or real estate.
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Investing Ideas For A Stagflationary Environment
Fidelity sector strategist Denise Chisholm has looked at previous periods of stagflation and says history provides an ambiguous guide for investing when growth is weak and inflation high. Defensive stock sectors such as consumer staples and health care have historically performed well in recessions but less so when growth has been merely slow. Similarly, while technology has benefited from low inflation, it hasn’t done badly when inflation has risen. That history suggests that the best approach is to be diversified and remember that inflation by itself is not necessarily a bad thing for stocks.
As Pineault says, “The price of a stock reflects how profitable a company is and if you have inflation, revenue can be higher. That means stocks typically are the most effective hedge against inflation.”
With that in mind, this may be a good time to put some Doobie Brothers or Captain and Tennille on the 8-track player and review your asset allocation.
Our Framework For Understanding Stagflation
Stagflation, which for purposes of this paper I will define as a combination of weakening real growth and rising/high inflation, typically occurs when demand is greater than supply at current prices and supply is unable to grow quickly to meet that demand. Excessive stimulus or money supply increases can be a driver, especially if the output gap is closed so that there is no excess capacity to raise supply and meet the increased demand, forcing prices to rise and ultimately destroy demand.
This process can be prolonged if it is met with additional increases in money supply and nominal incomes, which would at least temporarily preserve demand until prices rise further . If, on the other hand, there are no further increases in money supply and nominal incomes, the demand destruction would likely slow economic growth, perhaps to recession levels if negative feedback loops ensue or financial conditions are tightened to combat the inflation.
A second possible cause of stagflation is a shift down in the supply curve of the economy caused by an exogenous shock, such as the OPEC embargo or a currency crisis . The severity and persistence of the shock, along with the policy response, will tend to determine whether the result is a short bout of inflation followed by a slowdown or recession, or a longer-lasting stagflationary period in which
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How Things Were Different
Not that events will unfold in precisely the same way as before, of course. Professionals whose careers were forged decades ago see key differences between the period of the 70s through the early 80s and now. A chief source of anxiety then was inflation and the higher interest rates that came along with it. Investors today are preoccupied with a banking system that has all but collapsed, the prospect of deflation, and interest rates that have fallen practically to zero, leaving authorities with little room to maneuver as they try to revive the economy.
Inflation Is A ‘tapeworm’ That Makes Bad Businesses Even Worse For Shareholders
“A further, particularly ironic, punishment is inflicted by an inflationary environment upon the owners of the ‘bad’ business. To continue operating in its present mode, such a low-return business usually must retain much of its earnings no matter what penalty such a policy produces for shareholders.
“… Inflation takes us through the looking glass into the upside-down world of Alice in Wonderland. When prices continuously rise, the ‘bad’ business must retain every nickel that it can. Not because it is attractive as a repository for equity capital, but precisely because it is so unattractive, the low-return business must follow a high retention policy. If it wishes to continue operating in the future as it has in the past and most entities, including businesses, do it simply has no choice.
“For inflation acts as a gigantic corporate tapeworm. That tapeworm preemptively consumes its requisite daily diet of investment dollars regardless of the health of the host organism. Whatever the level of reported profits , more dollars for receivables, inventory and fixed assets are continuously required by the business in order to merely match the unit volume of the previous year. The less prosperous the enterprise, the greater the proportion of available sustenance claimed by the tapeworm.
… The tapeworm of inflation simply cleans the plate.”
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Top Five Stocks In The Last Twenty Years
During the last twenty years, different sectors and industries have transcended to new levels, mostly through merger and acquisition strategies. The two most prominent segm ents are biotechnology and technology, both of which have significantly expanded over the last twenty years. Here is the list of five stocks that have been the best long-term investments, yielding high returns.
Celgene Corporation is among the world’s largest biotech firms. Their market capitalisation is 61,586 billion USD. CELG shares were worth around $99.59 in February 2016, but after the adjustment for dividends and stock splits, their worth was only 70 cents in February 1996. Bringing compounding returns into the equation, it amounts to 28.1% in compounding app returns.
The company sells popular medications such as Revlimid and Thalomid. Through research and development and acquisitions, the organisation has been building a large drug portfolio. They also receive royalties on some of their products, in addition to their sales revenue.
The giant computer company known as Apple experienced an initial growth in the 1970s and 1980s. However, in 1996 Apple experienced a rapid decline. The company’s shares were worth only 91 cents, after adjustment for dividends and stock splits.
Wealthy As Likely To See Recession As Economic Expansion
Wealthy investors surveyed by E-Trade who describe the economy as expanding fell from 41% to 23% while those who see a recession increased from 14% to 23%. Those who described economic conditions as peak, including by definition that “inflation takes hold” and economic growth stops or slows, increased from 22% to 29%.
“It’s such a drastic shift in economic outlook quarter over quarter,” Loewengart said.
While it may seem surprising to see more of the wealthy describe a still-growing economy as being in a recession, there is a historical precedent for why they may feel this way. Inflation can run hot, at 3% to 4%, and co-exist with rising corporate profits, at least for a while, before action needs to be taken. It’s that potential action, from the Fed, though which Altfest says has the attention of investors.
“Cutting inflation means raising rates and in most cases the quickest way to get rid of serious inflation is by raising rates fast enough to cause a recession. If things really pick up that’s what is going to happen. Volcker got rid of inflation,” he said, alluding to the decision by then-Fed chairman Paul Volcker to sharply raise rates starting in the late 1970s and cause a recession as a way to control inflation.
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There Is No Solution To Inflation But There’s Reason For Hope
Buffett wrote in 1980, “The chances for very low rates of inflation are not nil. Inflation is man made perhaps it can be man-mastered. The threat which alarms us may also alarm legislators and other powerful groups, prompting some appropriate response.”
The recent action in stocks does not suggest faith in that response being adequate, but the chance that it’s adequate isn’t “nil,” either.
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Success Against The Virus Means More Focus On Higher Prices
Part of it is timing, not only the Fed’s.
As fears about the delta variant’s impact on the economy diminish, and vaccines become available even more widely, people are expecting that this time the virus really is under control and they can go out again and spend.
“The relationship between spending and inflation fears is pretty high,” said Lew Altfest, CEO of Altfest Personal Wealth Management. “The delta variant caused a postponement of the inflation discussion, but now it’s back and it does have the power to prevent the markets from making progress. So we are in the rethink period. Delta just pushed out the inflation discussion by limiting growth in the short-term, but now it is back to the fundamentals that increase visibility farther out,” he said.
While the recent GDP reading of 2% was a slowdown, Altfest noted that that services component was up significantly and there is likely more spending to come from the federal government, another tailwind for growth. “If growth really picks up again, then inflation will pick up,” he said.
The bond market is expecting it to, with a key reading moving up to a level indicating higher-than- anticipated inflation will last for years.
For First Time Since Q2 2020 Many Millionaires Think Record Stock Market Has To Stop
The percentage of millionaires who expect the market to end this quarter with a gain declined from 70% to 47%, according to the E-Trade data. Those who expect the market to drop increased by 21 percentage points, from 14% to 35%. The remainder were neutral.
This change fits the virus versus inflation paradigm as it’s the highest level of wealthier investors expecting a quarterly decline in stocks since Q2 2020.
“That’s a key shift,” Loewengart said. “In past quarters millionaire investors were near uniform in their belief that the market would continue to rise.”
A big disconnect, though: earnings are still coming in strong, despite some notable disappointments towards the end of last week including Amazon and Apple. Overall, the market is exceeding expectations in Q3 earnings and based on where analysts were into this earnings periods, forward estimates will have to be revised upward, which supports the market, which already is at a record.
Q2 2020 ended up being one of the best on record, but that came after the crash in Q1 2020 rather than stocks reaching new records on a regular basis. Investor sentiment trailed the actual market comeback in 2020, but this time around, there is less room in price-to-earnings ratios to quickly make up.
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Weaker Dollar Stronger Bonds
For alternative approaches to investing during a period of stagflation, it is instructive to look at the performance of the U.S. dollar relative to other currencies as well as relative to inflation during the heights of the 1970s stagflation. The chart below shows that not only were prices rising, but the U.S. dollar was declining relative to a basket of major world currencies. Although positions in dollar denominated assets such as gold and oil will help offset this effect, other asset classes can produce current income and attractive expected real returns in this environment.
Generally during periods of slow or negative economic growth, government bonds and cash perform well. But because of the inflation side of the equation, both of those options are not very appealing. Instead, investors need to look for alternatives, including outside the U.S.
In an environment of stagflation, an allocation to foreign bonds becomes attractive from an expected return perspective. Portfolios benefit from not only increased diversification, but also currency effects by holding bonds issued in local currencies from around the world. Bonds held in both developed and emerging markets can also generate attractive real returns during periods of a weakening currency and rising inflation in the U.S.
Next Steps To Consider
Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.
This information is intended to be educational and is not tailored to the investment needs of any specific investor.
Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.
In general, the bond market is volatile, and fixed income securities carry interest rate risk. Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.
Past performance is no guarantee of future results.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
Changes in real estate values or economic conditions can have a positive or negative effect on issuers in the real estate industry.
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