Stocks have been volatile this year. The S&P 500 dropped more than 10%, mainly due to inflation worries. Also, bond prices have fallen. Gold’s recent surge due to Russia’s invasion of Ukraine was before it. The metal that is known for its ability to protect inflation was in its worst year in six years, even though inflation rose to the highest levels in decades.
There is no one right way to invest in high-inflation markets. Wall Street does see some areas that may be more resilient than others.
Investors who had been used to low inflation for years didn’t see a significant change in their earning potential, says Gargi Pal Chaudhuri, head, iShares Investment Strategy, Americas at BlackRock. She stated that she believes the level of 1.5% to 2.2% will be much closer to 3% in the future and that it is time to think about where to go.
Investors don’t have to begin day-trading after years of a long-term, buy-and-hold strategy that worked well. They may wish to diversify their portfolios, and include parts of the bond and stock markets that can benefit from inflation. Let’s take a look at some options.
Inflation is less of a threat to bonds
Bonds should be considered the most secure part of any portfolio. However, if inflation is high, fixed payments that they make in the future will not be able to buy as much stuff.
The Federal Reserve is expected to raise interest rates again this year to reduce inflation. Consumer prices were 7.5% higher than last year’s January. Rates rise and new bonds are more expensive, so bonds in bond funds’ portfolios become less appealing, lowering their prices. As of Thursday, Vanguard’s Total Bond Market Index Fund had already lost 4.2%.
Chaudhuri stated that while it may seem shocking to lose money on bonds but that investors should not abandon them.
She said that bonds still provide you with the ballast at the end of the night. They are the ultimate diversifier and will still work in an environment when stocks are falling significantly.
Because investors are locked in at lower rates longer term, long-term bonds tend to be hit harder by higher rates. Some protection can be offered by shorter-term bonds.
Some bonds offered by the U.S. government protect against rising prices. The principal of Treasury Inflation Protected Securities (also known as TIPS) rises and falls with the consumer price index. The interest payments calculated on this principal amount also change. TIPS still offer negative yields with the 10-year TIPS currently at 0.50%.
An I-bond is another type of government bond that may prove more lucrative. The I-bond pays interest in two parts. One that adjusts to inflation and resets twice per year; the other that is set at purchase. The I-bonds are currently offering no interest on the second, but they pay a composite annual rate at 7.1%. These bonds are subject to limits and cannot be cashed out for more than one year. If investors cash out prior to five years, they will lose three months of interest payments.
Commodities that sparkle
Some commodities have done well in high-inflation years over the past decade. Surprisingly gold is not always one of these commodities.
Its value fell by 4% last year, despite inflation accelerating rapidly. It yo-yoed right through 2022, until fears about Russian aggression against Ukraine sent its price soaring.
Rich Weiss (chief investment officer, multiasset strategies), American Century Investments stated that “once inflation is already high”, gold’s hedging ability against inflation is less strong.
This could be because higher interest rates, which are the Fed’s usual remedy for high inflation, can cause gold to lose value. Investors may not be as willing to invest in gold if bonds pay more interest.
Other commodities have better track records. Weiss stated, “That’s almost absurd,” because inflation spikes are often caused by rising oil prices and other commodities.
Wall Street experts recommend that you consider investing in commodities-related ETFs. However, they may have higher costs than stocks and bonds funds.
Inflation-resistant stocks
The prospects for companies producing oil and other commodities will likely rise with inflation if they are increasing in price. Many strategists recommend focusing on energy stocks.
The S&P 500 has seen energy stocks rise more than 22%, while the overall index is down slightly more than 8%.
UBS Global Wealth Management strategists say that other areas of the market are likely to be more affordable in a world with rising rates and high inflation. Stocks that appear expensive, like big tech stocks, will likely be hit harder after their long and strong run, which was helped by low interest rates.
Because of higher long-term rates, financial stocks have not been as badly affected as the rest this year. This is because they are expecting to make bigger loans and therefore expect to be more profitable. However, there is still risk. Banks make the most money when they are able to borrow money at low rates and then lend it at higher long-term rates. They may feel the pain if they close that gap.
Inflation has been a problem in the past, but stocks from emerging markets have delivered in other instances. This is partly because many of these companies are commodities producers. They are also cheaper than the U.S. stock exchange, which has been the dominant force in the world for many years.
American Century’s Weiss stated that “COVID has stopped us from traveling abroad physically,” but that “but you definitely want the opportunity to travel overseas with your assets.”
