How investors can beat inflation

Frank Hemsley - Wed 28 Jun, 2006

...Reagan would know about the problems of high inflation because when he entered office, the United States was staring at double-digit inflation and an economy stuck in quicksand. Will that happen again? Who knows? But the May inflation reading of 4.17% is only the second- highest rate Americans have seen in the past 15 years. Inflation has to be the biggest concern for the Fed right now...

  
 
"Inflation is here and it’s not going away anytime soon," or so says the FOMC, as it gets ready to hike the Fed Funds target rate another 0.25% when the Committee meets on Thursday.

Some media "experts" and economists are even forecasting a 50 basis point increase to help tame the inflation animal. Doubtful.

Realistically, investors can expect a 25 bps increase this week and another 25 bps on August 8 to bring the target rate to 5.50%. The US economy is humming along and its enemy, inflation, is gaining steam. This kind of tightening from the Fed looks more than likely now.

How investors can beat inflation: Data is stronger than expected

All one needs to do is look at the data. The latest University of Michigan reading on consumer sentiment was reported higher than expected. Evidently, American consumers continue to smile, even though they’re being slammed by high petrol prices just as we are here.

And then, the Department of Commerce released a surprisingly positive US housing starts report: May housing starts increased by 5%, while the consensus expectation was for a 1% gain. Interestingly enough, the April figure even had an upward revision.

Demand is softening, however, as housing starts are still 14% below the January peak and the second quarter average is about 10% below the first quarter average. Any way you want to look at it, the housing market is simply cooling...and that’s a long way from collapsing.

How investors can beat inflation: Economy is warmer than room temperature

The economy is still growing at a rate that some would argue is warm, not hot, but it certainly isn’t room temperature. The Fed’s previous 16 rate increases have slowed down the economy, but it’s not doing too much to shut down the housing market.  

And, why should it? The media likes to sell us with stories about a housing collapse, and it always makes interesting reading after the Fed hikes interest rates because higher mortgage rates typically follow, thus slowing down the housing sector.

But, guess what: homebuyers don’t care. Even if US mortgage rates hit 7% this summer, as some mortgage bankers are predicting, they are still lower than the double-digit rates Americans witnessed in the late ‘80s and early ‘90s.

So, buyers are forced to buy a smaller house and sellers will settle for a slightly lower price. It doesn’t matter because as the data explains, a 7% mortgage isn’t going to stop people from buying what they want.

How investors can beat inflation: Inflation is a cancer

If I was Chairman Bernanke I would instruct all of the central bankers to worry about one thing and one thing only: Inflation. It needs to be stopped. Higher rates won’t kill the spirit of the American consumer, but inflation will. It paralyzes growth and discourages saving. It acts like a cancer - if it’s not controlled and stopped, it will kill the economy.

President Ronald Reagan once had a fitting quote: "Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man."

Reagan would know about the problems of high inflation because when he entered office, the United States was staring at double-digit inflation and an economy stuck in quicksand. Will that happen again? Who knows? But the May inflation reading of 4.17% is only the second- highest rate Americans have seen in the past 15 years.

Inflation has to be the biggest concern for the Fed right now.

How investors can beat inflation: Steps to take

Today, investors have many challenges when it comes to maintaining a well-diversified portfolio. In addition to extreme market volatility and saving for retirement or school for their kids, investors have another concern to worry about: Inflation.

Inflation affects everyone. It doesn’t matter which social class you are in or how much money you have in the bank - inflation can decimate your financial security because it erodes purchasing power and reduces what your money can buy.

So, what’s an investor to do? Well, the good news is there are opportunities available for you to guard your portfolio against inflation.

1.    INDEX LINKED SAVINGS

You’re never going to become a millionaire over night with these certificates offered by National Savings & Investments (NS&I). But they’ve been going for 31 years and are very popular as a way of keeping up with inflation as measured by the Retail Price Index.

2.    SHARES

Buying and holding onto shares is another way to cure the inflation bug because returns on shares have generally outpaced inflation rates. For example, the S&P 500 has gained 10.4% annually from 1926 through 2004, easily beating average inflation rate during that time.

Shares of smaller companies have performed even better, returning 12.7% annually during that same time period.

To compare, bonds have had a tougher time winning the race against inflation. In fact, intermediate-term government bonds have delivered an annualized rate of just 5.4% over the long run.

3.    GOLD

Commodities like gold typically perform well during periods of inflation while often providing equity-like returns over time. This bullish action is because the money backed by gold cannot be created arbitrarily by government action.
By removing this uncertainty in currency, gold tends to appreciate during periods of inflation and makes a terrific complement to your inflation-fighting portfolio.

The American Fed has its hands full with the inflation battle, but these suggestions could help curb any concerns you may have for your portfolio over the longer term.


Regards,

Frank Hemsley
for The Daily Reckoning

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