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Inflation and our Investments

My father-in-law who was a real estate trader used to tell me regarding housing “It’s all about location, location, location”. “This is a cliché in determining the desirability of a property and it dated all the way back to real estate magnate” Harold Samuel (founder of Land Securities, the largest public landowner in the UK). 

I will borrow this concept for this article and state that the entire market and economy today revolves around “inflation, inflation, inflation”! 

First and foremost, despite heavy inflation on many food items, the US will be closed on the 4th of July to celebrate the declaration that the thirteen colonies were no longer subject to the monarch of Britain King George III. 

The four drivers of inflation now are:

  1. Supply chain disruptions 
  2. Excess capital paid into the system 
  3. Excess savings that accumulated during the pandemic
  4. Energy prices (and other commodities) increasing because of the war in Ukraine

It seems that the first three will resolve themselves in due time and the last is supply-side inflation, which if not controlled correctly can turn to demand-side inflation.

This is an important differentiator as the largest fear would be that we will return to the inflation realities of the eighties. The contrast between now and then energy prices have decreased from double digits down to single digits in our annual spending budgets.

The same thing is the case for food, and instead, most of our spending is made on discretionary items like vacations and eating out. These items are easier to rein in during inflationary times and therefore are more easily controlled. 

The pandemic is no longer a challenge for growth as we are almost back to full recovery. As the charts from JP Morgan Asset Management showcase, consumer credit transactions are actually up 31% from the low point of the crisis, hotel occupancy is only 6% down, restaurant dining is down only 3%, and travel only down 11% (which might be much less if it wasn’t for the strikes). This has led to earnings year-over-year not only being higher but in fact, they have beat expectations. 

So, that is why financial planning is so crucial to adapt our investments to our goals, instead of the other way around. 

Bond values are down because interest rates have gone up, and unemployment is reaching historic lows, which should be a good thing, except that this drives up wages which becomes inflationary. When inflation increases, interest rates increase to try to combat them, which in turn pulls down valuations. 

Once again, it’s inflation, inflation, inflation! 
 
The good news is that Inflation should moderate over time, but I don’t see it getting back to the government target in the US, the UK, or Europe of 2% anytime soon. However, the longer high inflation persists, the stickier it gets and that is what affects interest rates. 

So, what should our strategy be now to protect ourselves against this challenge? A few ideas: 

  1. Reallocate Money Into Stocks

If inflation returns, it’s generally a punch in the usual problem for the bond market, but it could be a shot in the arm for the stock market. Consider reallocating part of your portfolio 

Buying preferred stocks is another possibility. These liquid issues will pay a higher yield than most types of bonds and may not decline in price as much as bonds when inflation appears.

Utility stocks represent a third alternative, where the stock price will rise and fall in a somewhat predictable fashion through the economic cycle and pay steady dividends.

  1. Diversify Internationally

Investors tend to lean towards local stocks, but the practice can be costly over the long term, especially during times of inflation. Increasing international exposure can be a good strategy to hedge against inflation.

Several major economies in the world do not rise and fall in tandem with the Israeli market indices, such as the US, Italy, Japan, Australia, and South Korea. Adding stocks from these or other similar countries can help to hedge your portfolio against domestic economic cycles. 

  1. Consider Real Estate (especially with CPI-linked contracts) 

There are many advantages to investing in real estate. This asset class has intrinsic value and provides consistent income through dividends. It often acts as a good inflation hedge since there will always be a demand for homes, regardless of the economic climate, and because as inflation rises, so do property values. Therefore the amount a landlord can charge for rent.

Because real estate is a tangible asset, however, it’s illiquid. An alternative to consider is real estate investment trusts (REITs) or just Real estate Investment Funds, which are more liquid investments and can be bought and sold relatively easily in the markets. REITs are companies that own and operate portfolios of commercial, residential, and industrial properties. Providing income through rents and leases, they often pay higher yields than bonds. Another key advantage is that their prices probably won’t be as affected when rates start to rise, because their operating costs are going to remain largely unchanged. 

About the Author
Dan Dobry was the founder and a director of the GlobalNET Investment House, he was one of the founders of the Union of Financial Planners in Israel (UFPI) and served as the first Chairman and President of UFPI. Dan was the Global Council Representative for Israel for the Global Community (FPSB) from 2012 - 2018 and was a member of the Committee for Standards and Qualifications for the European Union (SQC) until December 2021.
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