The 3 Best Ways to Protect Your Portfolio from Runaway Inflation
The era of very low inflation seems to be coming to an end. Food prices started to perk up in 2010, oil prices are on the rise now and, before long, a wide range of companies may need to push up their prices to account for their own rising costs.
This can end in one of two ways: with higher — but still manageable — inflation, or it could trigger a vicious cycle of rising inflation expectations that create even greater inflationary pressures. It’s not just about food, oil and other raw materials, either. There’s a also a macro-economic concern: if the United States starts to struggle to find buyers for its debt, it will need to offer far higher bond yields, the dollar would come under pressure and imports into the U.S. would be subject to major inflation pressures.
Right now, this doomsday scenario is no sure thing. And it would take several years of pressure to really put inflation on the boil. But you need to start thinking about it now, gradually adjusting your investment exposure as any inflationary signs begin to emerge. My colleague Tom Hutchinson recently weighed-in on three investment classes that will help hedge against inflation. I would add these three types of investments to further “inflation proof” your portfolio.
1. Multinational exporters
For a host of reasons, a falling currency boosts inflationary pressures, and inflationary pressures tend to weaken a currency. And once this perilous dance begins, it’s hard to stop. That’s why you need to own multi-national blue chips such as McDonald’s Corp. (NYSE: MCD), Procter & Gamble (NYSE: PG) and Caterpillar (NYSE: CAT). Their exposure to calmer foreign economies will help smooth out their results, while they’ll also see a boost in foreign-earned profits as they are repatriated back into a weaker dollar. [I also like the three exporters mentioned here in my recent article.
2. Stable foreign blue chips
Certain countries have developed very strong economic foundations that have attracted global investors in search of low inflation risks. Countries such as Switzerland, Japan and Norway can easily withstand the impact of rising commodity costs, thanks to a high degree of energy efficiency and very sound government finances. More than likely, these countries’ stock markets will stand up better in an era of rising global inflation, as their own economies remain relatively unperturbed. You can go with their blue chips such as Switzerland-based Novartis (NYSE: NVS) or Japan’s Canon (NYSE: CAJ). You can also look to own a basket of these countries’ currencies by buying a broad-based currency exchange-traded fund (ETF) such as the CurrencyShares Euro Trust (NYSE: FXE) or the PowerShares DB G10 Currency Harvest (NYSE: DBV).
3. Real estate
Few people think of real estate when they think of inflation. But they should. Of course, home prices are subject to a range of economic forces in the near-term, but in the long-term, they are simply a function of purchasing power. If inflation builds over time and workers secure higher earnings to keep up with inflation, their relative purchasing strength moves up in tandem.
As an example, my parents bought a home in the early 1970s for $33,000. 10 years later, they sold it for roughly $230,000. It’s not that they were particularly savvy about real estate. Instead, they simply benefited from the fact that inflation was at high levels throughout that period.
To be sure, interest rates would rise in an inflationary environment, so housing prices might take a hit in the near-term as the cost of a mortgage might rise higher as well. Yet, over the long-haul, inflation would again be tamed and then eventual drop in rates would help you to catch up on any lost years of appreciation. Falling rates in the 1980s and 1990s made mortgage rates much more attractive, which sharply expanded the purchasing power for many homeowners.
Now is a great time to be thinking about a real estate purchase, despite the sobering headlines. Interest rates remain relatively low and home prices in many regions are well off of their highs. If you buy a $200,000 home now and take out a $150,000 mortgage, you’ll be very pleased later on if inflation kicks in. As home prices keep up with inflation, that home might be worth $400,000 in 10 or 15 years, yet you’d still only be making payments on a $150,000 mortgage.
Action to Take –> This is a good time to start keeping an eye on government price reports. In the middle of every month, you can get a snapshot of both producer and consumer price trends. The next readings come on March 16 and March 17, respectively.
Note that many economists also discuss inflation trends excluding food and energy pieces, which can be volatile. Yet, that may not make sense any more. These two categories look to be on a new, higher plane, and their impact is not fleeting. For example, oil prices may well fall back below $100 a barrel, but they are very unlikely to re-visit the sub-$70 levels seen a year ago. And a rising global middle class has put real strains on food prices, which are unlikely to abate any time soon.