Financial Professionals

August 30th, 2021

3 Factors to Consider When Considering Inflation Hedges

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Inflation has been a front-and-center topic in recent months, mostly because it’s been moving higher. Consumer prices (CPI) rose 5.4% in July 2021 from July 2020, which marked the highest 12-month jump since 2008.

There was one silver lining in the CPI fine print, however – inflation rose at a 0.5% pace from June to July, which marked a material slowdown from the 0.9% increase from May to June. Even still, the average pace of increase was 0.2% from 2000 to 2019, so inflation is currently moving twice as fast in 2021 as compared to previous decades.1

It’s still up for debate whether inflation will ultimately prove “transitory” as the Federal Reserve believes, or whether inflation could be stickier. In either case, investors would be well served to understand what types of investments could serve as effective inflation hedges, and which ones don’t. Here are three factors to consider.

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What Can You Do When Inflation is Worrying You?

Inflation can be an unsettling topic for many investors. Many questions arise like – How long will it last? What type of inflation hedges may work in portfolios? Instead of making hasty decisions, I recommend reviewing the fundamentals and hard data.

Get answers to these questions and more with our just-released Stock Market Outlook report. This report contains some of our key forecasts to consider such as:

If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! 

IT’S FREE. Download the Just-Released September 2021 Stock Market Outlook
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  1. Why Stocks Have Historically Been Good Inflation Hedges

To understand why quality stocks have historically been good inflation hedges, consider a hypothetical example involving Coca-Cola.

Let’s say sticky inflation drives up the prices of syrup, cans, and labor, all of which increase the cost of producing one can of coke. Rising costs theoretically hurt Coca-Cola’s bottom line, unless they raise the price for a can of coke – which they will. Coca-Cola has pricing power, meaning they can raise the prices of their product without driving away significant numbers of customers. In this way, pricing power gives companies – and shareholders – the ability to maintain profits even as inflation goes up.

Investors may also want to consider the distinct possibility that value stocks may hold up better in an inflationary environment than growth stocks. The reason why, in my view, has to do with earnings. Growth stocks’ earnings are generally further out in the future than value stocks’ earnings, meaning the present value of those future earnings is more sensitive to higher interest rates (which are often driven higher by inflation). That’s why in the past I’ve warned readers that the possibility of rising interest rates in the coming quarters and years are likely to impact high valuation stocks, like Tech shares. 

For decades, it has been a popular view that gold is a reliable and effective inflation hedge. The data simply doesn’t support it, though.

A recent study by some economists at Duke University looked at the ratio of gold to the consumer-price index over long periods. If gold was a reliably good inflation hedge, the ratio between gold and the CPI should have remained relatively steady over the years. It didn’t – over the past 50 years, the ratio of the price of gold to the CPI has fluctuated from 1.0 to 8.4, indicating fairly wild swings and dismissing the notion of ‘reliable.3

The researchers concluded that gold has done a relatively good job of maintaining purchasing power over a time horizon that’s much longer than anyone actually lives – a century or more. If you consider shorter time frames like a few decades, however, gold’s inflation-adjusted price fluctuates just as much – if not more – than other risk assets.

Then there’s the bottom line, which is long-term total return. Since 1971, the S&P 500 has generated an annualized return of +11.2%, while gold has delivered a significantly lesser +8.2%. If you strip out the decade following President’s Nixon announcement that dollars could be converted to gold at a fixed rate – which was the decade where gold performed the best – stocks annualized +12.2% compared to just 3.6% for gold. Even Treasuries did better, at +8.2%.

Finally, there are bonds to consider. In an inflationary environment, an investor who holds bonds to maturity gets paid back what he/she lent a borrowing government or company, and those dollars are almost certain to have less purchasing power five, ten, or 30 years later. What’s more, an inflationary environment will produce higher interest rates, and rising rates mean falling bond prices – not great for investors.

This is not to say that bonds are outright bad for inflationary environments. It just means that investors need to actively manage their bond portfolios to ensure their total return and income needs are constantly being addressed.

Bottom Line for Investors

It remains unclear how impactful inflation will be in 2021, but it makes sense for investors to think about what type of inflation hedges may work in portfolios. As I’ve detailed above, stocks are not immune to inflationary conditions, but they have historically done the best job – in my view – of consistently delivering returns needed to maintain pricing power over time.

It’s important to understand how to navigate through inflation. We recommend staying focused on key economic indicators. Our Just-Released September 2021 Stock Market Outlook Report4, will give insight into all of it!
 
This report is packed with newly revised predictions that can help you base your next investment move on hard data. For example, you’ll discover Zacks’ view on:

If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today!

Disclosure

1 Wall Street Journal. August 11, 2021. https://www.wsj.com/articles/us-inflation-consumer-price-index-july-2021-11628633099

2 Zacks Investment Management reserves the right to amend the terms or rescind the free Stock Market Outlook offer at any time and for any reason at its discretion.

3 Wall Street Journal. August 9, 2021. https://www.wsj.com/articles/gold-as-an-inflation-hedge-what-the-past-50-years-teaches-us-11628283272?mod=article_inline

4 Zacks Investment Management reserves the right to amend the terms or rescind the free Stock Market Outlook offer at any time and for any reason at its discretion.

DISCLOSURE

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

Any projections, targets, or estimates in this report are forward looking statements and are based on the firm’s research, analysis, and assumptions. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice. Clients should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed in this presentation.

Certain economic and market information contained herein has been obtained from published sources prepared by other parties. Zacks Investment Management does not assume any responsibility for the accuracy or completeness of such information. Further, no third party has assumed responsibility for independently verifying the information contained herein and accordingly no such persons make any representations with respect to the accuracy, completeness or reasonableness of the information provided herein. Unless otherwise indicated, market analysis and conclusions are based upon opinions or assumptions that Zacks Investment Management considers to be reasonable. Any investment inherently involves a high degree of risk, beyond any specific risks discussed herein.

The S&P 500 Index is a well-known, unmanaged index of the prices of 500 large-company common stocks, mainly blue-chip stocks, selected by Standard & Poor’s. The S&P 500 Index assumes reinvestment of dividends but does not reflect advisory fees. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor. An investor cannot invest directly in an index.

The MSCI ACWI captures large and mid-cap representation across 23 Developed Markets (DM) and 27 Emerging Markets (EM) countries. With 2,986 constituents, the index covers approximately 85% of the global investable equity opportunity set. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The MSCI UK All Cap Index captures large, mid, small and micro-cap representation of the UK market. With 819 constituents, the index is comprehensive, covering approximately 99% of the UK equity universe. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The Russell 1000 Value Index is a well-known, unmanaged index of the prices of 1000 large-company value common stocks selected by Russell. The Russell 1000 Value Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot directly invest in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The Russell 1000 Growth Index is a well-known, unmanaged index of the prices of 1000 large-company growth common stocks selected by Russell. The Russell 1000 Growth Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.
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