Updated: Nov 11, 2021
Finding the right balance in an inflationary world
Brendan Greenwood CIM, B.Comm | November 9, 2021
Have you filled your gas tank recently or taken an Uber and been surprised by the cost? You’re not alone. Over the past year inflation has surged with Statistics Canada and the US Bureau of Labor Statistics reporting rates of 4.4% and 5.4%.
Globalization has been deflationary. It brought down the cost of goods and services as businesses outsourced production throughout their supply chain taking advantage of cheaper labour and expertise around the world. Consumers in wealthy nations benefitted by paying lower prices for
goods and services.
In recent years protectionists measures such as more restrictive application of regulations and higher tariffs that we see for example in the US-China trade dispute have increased the cost of goods for consumers. These measures slowdown and make it more difficult and costly for companies to manage their supply chains. A sustained reversal of globalization would put continued upward pressure on prices paid for goods.
Globalization enriched Nations, but remains contentious…
Global trade has enriched countries through access to larger markets and more focused innovation. However, this remains a contentious issue as large portions of the population continue to feel disenfranchised by the outsourcing of jobs. Also with the climate crisis falling more into focus, many more people are becoming concerned about the carbon emissions produced by shipping goods around the world.
The economy has been buoyed by loose monetary policy. Interest rates are near zero. Central banks have been running bond buying programs, also known as quantitative easing. Governments around the world have been running all sorts of programs to put money in the hands of businesses and individuals adversely impacted by the pandemic. With individuals and businesses having spent less during the economic slowdown, they are flush with cash as the recovery takes hold. We have a supply imbalance with too much money chasing available product driving prices up.
Will inflation slow down?
Reducing quantitative easing, future interest rate hikes…
The Bank of Canada is scaling back it’s bond buying program reducing money supply in the system. The US has also indicated it plans to take similar measures with interest rate hikes planned next year to further curb demand driven inflation. With the Bank of Canada rate at a low of 0.25% a small increase in interest rates could have a profound impact on the money supply. Higher interest rates drive up borrowing costs, reducing the amount of money in the system putting downward pressure on prices.
Supply chain fixes…
Production issues, bottlenecks and people issues will eventually be sorted out reducing upward pressure on prices by making more product available. However this process is taking longer than originally anticipated.
How can you continue to both grow and protect your investments from inflation and higher interest rates?
Portfolio Inflation Fighters…
Value Stocks – These are stocks of companies that own real assets such as real estate, land or equipment that will rise in value in response to a rise in prices. These businesses can often increase their prices to keep pace with inflation. The value factor attempts to capture excess returns available to stocks that are trading at prices below their fundamental value. Value stocks have outperformed during periods of high inflation producing greater real rates of return.
Small Cap Value Stocks - The smaller size of these companies adds a size factor that can help to capture excess returns. It should be kept in mind that these stocks are typically more volatile and exposure may be better gained through the use of funds that track a basket of these companies.
Treasury Inflation Protected Securities - If you’re looking for a stabilizing force in your portfolio to protect purchasing power and provide the opportunity to buy discounted assets when volatility strikes treasury inflation protected securities are worth considering. Their price will rise with inflation and they are not negatively impacted by interest rates hikes like traditional bonds which can fall in value when rates rise.
Riskier Inflation Hedges…
Growth Stocks - These companies are often dependent on the projected value of future cash flows. With higher interest rates the present value of those future cash flows are worth less leaving growth stocks more vulnerable to inflation and interest rate hikes.
Energy Stocks – These stocks have risen as the economic recovery takes hold. Global energy supply has been constrained and global demand is increasing, driving up profits for energy producers. In the past this sector has been a good hedge against inflation and provided higher real rates of return. Energy stocks can be volatile and have lagged the broader market in the past for long periods of time.
Gold -Even though the price of gold tends to track inflation if you observe the price history of the yellow metal. There have been decades where gold has failed to keep up with rises in the cost of living.
Bitcoin - The limited supply of Bitcoin has made it an often talked about great hedge against inflation, but its extreme volatility means it may not provide stability when you need it most.
The future is unpredictable. A balanced approach that avoids over-weighting your portfolio with riskier inflation hedges such as gold, bitcoin and energy stocks works best. Think about allocating a reasonable portion of your portfolio to inflation fighters mentioned in this article. These investments will help cushion your portfolio from the worst impacts of rising inflation and interest rates while providing greater real return potential to your portfolio as a whole.
Brendan Greenwood is an Investment Advisor with Worldsource Securities focused on personal pension strategies and leveraging technology to provide progressive institutional style investment solutions for professionals, incorporated individuals, business owners, retirees and their families.
For other articles authored by Brendan Greenwood on issues impacting business owners and individual investors see https://www.greenwoodwealth.co/blog.
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