The official narrative among the world’s central bankers is that inflation is “transitory”. Prices are rising now, but that’s just because we’re reopening the economy and supply chains are readjusting. In the longer run, we don’t need to worry. Perhaps.
But before you take the official view at face value, it’s worth remembering that almost no one in the mainstream economic establishment or in a position of monetary authority saw any of this coming at all. Soaring energy costs and rising wages in key parts of the labour market might wash out over the coming months, but if you’d rather be safe than sorry, how can you position yourself in case the official line is wrong (again)?
Investing to beat inflation
James Montier and Philip Pilkington have looked at how to position portfolios for inflation in a new paper for US asset manager GMO. They note that there are two aspects here – one is hedging against inflation in the short term, which is more applicable to institutional investors and traders. For long-term investors (such as MoneyWeek readers), the key is to find assets that operate as decent stores of value – they won’t necessarily react to every inflation move and might even struggle at points in the cycle, but over time they’ll deliver real returns.
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The asset class most people turn to first is commodities. Yet as Montier and Pilkington note, one of the main reasons that commodities are seen as a great inflation hedge is because one in particular – oil – did tremendously well during the inflation of the 1970s (although to be fair, commodities in general “just about acted as a store of value”). The risk today is that oil shocks were a key component of the 1970s inflation and while that may be repeated there’s no guarantee.
Gold also did well over the decade, but the pair are cautious on its prospects – due to its lack of cash flows, “we really don’t have a way of knowing whether we are paying a high or a low price for any insurance properties that gold may offer”. (We still like gold, but they’re entitled to their view.)
The good news is that one asset class does stand out – cheap stocks. Even though markets massively derated (ie, the amount that investors were willing to pay for a given level of earnings collapsed) during the period, US equities still just about beat inflation between 1967 and 1980, while value stocks did far better. And of them all, commodity stocks did best. “We suspect they did much better than the underlying commodities as a store of value because they were cheap – something that today may well be true again.” For exposure to oil and gas, consider the iShares Oil and Gas Exploration and Production ETF (LSE: SPOG), while for exposure to mining stocks try BlackRock World Mining Trust (LSE: BRWM).
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