Protecting Your Portfolio in Inflationary Times

By Jane Young, CFP, EA

A Bank of America Fund Manager Survey conducted in the first week of March, found that professional investors believe inflation is the biggest threat to the market.   March was the first time Covid concerns were not the biggest concern.

Currently the consumer price index is up about 1.7% from a year ago and is expected to increase to around 2.5% later this year.  Producer prices are up about 2.8% from a year ago with faster growth further up the producer pipeline.  The Federal Reserve has set an inflation target at an average of 2% through 2022.  They want to encourage a moderate increase in inflation while holding interest rates low until that happens.  

Fears of inflation are being fueled by the anticipation of a strong economic rebound from the pandemic combined with massive government stimulus programs.  The money supply has increased about 25% from a year ago.   Much of the increased money supply is sitting idle in bank accounts because consumers and businesses are using this money to pay down debt, increase savings and hold as a buffer in case of worsening conditions.  Industrial production is down from a year ago, but Americans have substantially higher disposable income.

Although the increase in savings may dramatically increase demand it is unlikely to cause a huge, short term increase in inflation.   Price growth is slow moving, and inflation is strongly influenced by long term expectations.  It takes time to change consumer sentiment and many industries are reluctant to dramatically increase prices for fear of losing customers.   Additionally, there is widespread unemployment throughout many sectors of the economy.   This pool of unemployed workers can be hired to help address supply shortages as demand increases.

A major trigger of inflation is when supply cannot keep up with demand resulting in price increases. Greater productivity can improve supply and ease inflationary pressure.  Out of necessity the pandemic forced many companies to become more flexible and implement new technology at an astronomical pace.  Rapid development and implementation of new technologies and methodologies has led to greater productivity and increased supply of goods and services.  This will help companies meet the surge in demand and keep inflation in check.

It is difficult to predict inflation, but it is unlikely to skyrocket anytime soon.  However, to protect your portfolio during inflationary times continue to invest in the stock market.  The stock market tends to outpace inflation especially over long periods of time.  Value stocks and companies that provide necessities tend to perform well in inflationary times.  Value stocks are currently trading at a discount of 52% to growth stocks.  Growth oriented stocks that are valued based on cash flow and earnings in the future may not perform as well.

In the fixed income category, consider shorter duration and higher-yielding bonds and Treasury inflation-protected securities (TIPS).  Investments that are tied to physical assets such as real estate or commodities like gold have also performed well during rising inflation.