Inflation Strategies

[2000cs]

Originally Posted by mdf

Bloomberg had an investment/management interview. Cathie Wood talks about deflation.

https://www.bloomberg.com/news/featu...uality-hackers

Interesting perspectives, thanks for posting this article.

[VertigoAtHome]

I use the bucket approach (i.e. harvesting plan) where you keep enough cash to fulfill your needs after you subtract guaranteed income streams. This allows you to stay invested through a bear market w/o being forced to sell. I've lived through the 2000 and the 2007 bear market and 7 yrs cash seems to be right. However I was somewhat surprised to see the S&P chart chassis posted that I believe shows inflation adjust returns. Once inflation is introduced it shows a 24 yr (68-92) period where you went nowhere in real terms and again a much longer period that I thought to recover from 2000 bear market. I don't know if dividends were included, but none the less, it shows what has happened and can happen in the future. I doubt I'll see that kind of inflation again in my lifetime and am comfortable using equities as a hedge against inflation but the chart is sobering.

[chassis]

VertigoAtHome the chart in your post is SP500 price only, for avoidance of doubt.

During the inflationary period of 1975-1981, the S&P total return was 12+% annually and government bond yields were around 8%. Compared with inflation of 6%. Do you agree on that for the period in question?

[VertigoAtHome]

Originally Posted by chassis

VertigoAtHome the chart in your post is SP500 price only, for avoidance of doubt.

During the inflationary period of 1975-1981, the S&P total return was 12+% annually and government bond yields were around 8%. Compared with inflation of 6%. Do you agree on that for the period in question?

Yes, looking at a CAGR calculator (MoneyChimp) for that period it's 8.6%, add in dividends and it jumps 14.1%, add in inflation and it's down to 4.2%. That isn't terrible, in fact given the inflation back then it's good, better than if you started investing in Jan 2000, by Dec 2007 you have a negative return adjusted for inflation. On your point, I agree equities is a good approach, and probably the best approach in today's market. That's where my money is!

However you can pick periods that change the outcome. What if you invested in 1968 (i.e. not near the bottom of the bear market) and were 65 yrs old. By 1981 when you are 78, you'd have a -1.51% return including dividends and inflation over that period. So for those like me who use the bucket approach to investing, having 5, 7, 10 yrs cash certainly helps, but won't necessarily get you to the other side bear market before you need to start selling. That said, I still think it's the best strategy, particularly in todays market. I've included an inflation adjusted S&P chart below for reference.

[TexasJester]

I’m nobody but I say if your doing what all the other sheep or doing, what all the experts are telling you and every other tom, dick & Harry to do you just might be on the wrong track. My plan is research and buy a business or businesses that are profitable and require as few employees as humanly possible.

[chassis]

Originally Posted by VertigoAtHome

Yes, looking at a CAGR calculator (MoneyChimp) for that period it's 8.6%, add in dividends and it jumps 14.1%, add in inflation and it's down to 4.2%. That isn't terrible, in fact given the inflation back then it's good, better than if you started investing in Jan 2000, by Dec 2007 you have a negative return adjusted for inflation. On your point, I agree equities is a good approach, and probably the best approach in today's market. That's where my money is!

However you can pick periods that change the outcome. What if you invested in 1968 (i.e. not near the bottom of the bear market) and were 65 yrs old. By 1981 when you are 78, you'd have a -1.51% return including dividends and inflation over that period. So for those like me who use the bucket approach to investing, having 5, 7, 10 yrs cash certainly helps, but won't necessarily get you to the other side bear market before you need to start selling. That said, I still think it's the best strategy, particularly in todays market. I've included an inflation adjusted S&P chart below for reference.

VertigoAtHome I see how your example works and the math holds water. And it is cherry picking a time period to look for the perfect storm.

When picking the perfect storm, it is reasonable to pick the average American in 1968. Defined benefit pensions were far more common, so on average the hypothetical 65 year old in 1968 would have pension income, in addition to Social Security income, to reduce the portfolio withdrawal rate. Employer-sponsored retiree health coverage was also more common, reducing out of pocket healthcare expense. Add to this the self-regulating behavior of an individual's spending patterns as net worth ebbs and flows.

We agree that equities are, in general, the best place to invest for the medium and long term, during almost any economic scenario.

I take issue when people on threads like this open the dark closet and bring out the 1970s Inflation Zombie. That zombie wasn't scary then, and shouldn't be scare now, because of the data you presented on equity and bond returns during that period.

Side topic - think about the benefit to Federal tax revenue from RMDs, related to growing retiree assets. It almost seems like aligned objectives between the government and investors. Investors who are also taxpayers. The more money a retiree has in their tax-advantaged retirement accounts because of market appreciation, the more RMD-related tax revenue Uncle Sam gets. I think this is close to a win-win. Therefore the Federal government seems likely to implement policy measures generally supportive of financial asset growth.

[2000cs]

Originally Posted by chassis

VertigoAtHome I see how your example works and the math holds water. And it is cherry picking a time period to look for the perfect storm.

When picking the perfect storm, it is reasonable to pick the average American in 1968. Defined benefit pensions were far more common, so on average the hypothetical 65 year old in 1968 would have pension income, in addition to Social Security income, to reduce the portfolio withdrawal rate. Employer-sponsored retiree health coverage was also more common, reducing out of pocket healthcare expense. Add to this the self-regulating behavior of an individual's spending patterns as net worth ebbs and flows.

We agree that equities are, in general, the best place to invest for the medium and long term, during almost any economic scenario.

I take issue when people on threads like this open the dark closet and bring out the 1970s Inflation Zombie. That zombie wasn't scary then, and shouldn't be scare now, because of the data you presented on equity and bond returns during that period.

Side topic - think about the benefit to Federal tax revenue from RMDs, related to growing retiree assets. It almost seems like aligned objectives between the government and investors. Investors who are also taxpayers. The more money a retiree has in their tax-advantaged retirement accounts because of market appreciation, the more RMD-related tax revenue Uncle Sam gets. I think this is close to a win-win. Therefore the Federal government seems likely to implement policy measures generally supportive of financial asset growth.

I’m going to disagree on a couple of points. While you are correct about DB and medical plans at the end of the 1960s, the problem many retirees encountered in the 1970s is that the payouts did not have inflation protection (not indexed), so those fixed annual annuity payments lost substantial purchasing power. This was a real problem at the time, and a significant factor behind California’s Proposition 13 (prop tax limitations). At the time social security payments were not indexed to inflation either, and income tax brackets were not indexed (as they still are not), so inflation lowered purchasing power, did not raise retirement income for those without a portfolio, and did raise taxes for those with a portfolio.

Also, the RMD argument ignores that a lot of the return in an IRA/401(k) is capital gain, but it is taxed at distribution as ordinary income. As a taxpayer, I don’t consider that a win-win, especially given that the RMD increases with portfolio size, pushing the investor into a higher tax bracket once again. To me it looks like inflation favors the federal government and not the retiree.

So the 1970s inflation was scary for a lot of people, especially anyone on a fixed income. Today some fixed incomes are indexed (social security) and some are not (many DB plans, annuities). So it might not be as traumatic as the 1970s but still something to try to guard against if in the fixed income category (and the inflation scenario).

On the positive side, anyone who got into a house or other real estate before the early 1970s could ride that wave (in many markets, I’m sure there were local areas where there wasn’t enough appreciation to cover the carry and transaction costs).

[Bongoxxx]

Originally Posted by tom2021

In Canada, we only can get mortgage rate fixed for maximum 5 years.
The mortgage is amortized for 25 years and the term is renew every 5 years.
Off course, there are variants of amortization years, variable rate, 1 to 5 years fixed rate.

?

In Canada you can get fixed mortgage terms anywhere from 6 months to 10 years.

And amortizations can be up to 40 years - if you qualify. You are limited to 25 year amortization if your mortgage is insured by CMHC (less than 20% down payment).

[tom2021]

For diversification and preservation of capital, TIPS is a good investment.
I look into STIP this morning. It is an etf for TIPS. Yield is 3.85%.
However. the price dropped in recent months, although the inflation data show the rate is climbing up.
I understand the dropped yesterday was due to the ex date on dividend.

Any thought?

[mdf]

James Grant, Grant's Interest Rate Observer, was interviewed on WealthTrack this week. He talks a bit about inflation, among other topics, like gold. He mentioned an inflation ETF I had never heard of, Inflation Beneficiaries ETF "INFL", "investing primarily in the equity securities of companies that are expected to benefit from rising prices." If I read it correctly the fund inception date is Jan this year, and I was curious to read through their top holdings. Episode is free on YouTube if you are curious:

www.youtube.com/watch?v=LiWe96aAtrw

INFL and gold youtu.be/LiWe96aAtrw?t=1320

[chassis]

2000cs Yes good points on lack of inflation indexing on pensions and SS. Also, household exposure to equity markets in the 1970s was half of what it is today. So while dividend yields and bond yields were better in the 1970s, fewer households took advantage of the higher yields.

This chart shows the decrease in dividend yields over time, I think it paints the picture pretty well.

[2000cs]

Yesterday Fed Chair Powell officially removed “temporary” from the Fed’s description of inflation, noting that it will be here for a while and that the Fed will use its tools to battle it. Those tools are accelerating the taper and raising interest rates. The taper is likely to accelerate immediately, not clear yet when the first interest rate raise will be.

The Fed’s anticipated actions to throttle back inflation will also reduce growth, which itself was already challenged by supply problems (thus inflation). And effectively the Fed is using monetary policy to fight the fiscal stimulus coming out of Congress. So it seems we are in, or will shortly be in a period of stagflation. This is rising prices but low to no growth. This will last at least 6 months, likely more than a year. If the Fed is unsuccessful, we could either go into a recession or experience stagflation for multiple years.

So, in these scenarios, what are your thoughts on investment strategies to generate real returns?

[zx10guy]

Glad I've started my refi of my primary home before all of this has blown up. I'm going from a 3.75% 30 years fixed to a 2.874% 30 years fixed and pulling about $100k of cash out.

[ASAP]

So uh... when does it all tank? Stars seem to be aligning.

[chassis]

Originally Posted by 2000cs

Yesterday Fed Chair Powell officially removed “temporary” from the Fed’s description of inflation, noting that it will be here for a while and that the Fed will use its tools to battle it. Those tools are accelerating the taper and raising interest rates. The taper is likely to accelerate immediately, not clear yet when the first interest rate raise will be.

The Fed’s anticipated actions to throttle back inflation will also reduce growth, which itself was already challenged by supply problems (thus inflation). And effectively the Fed is using monetary policy to fight the fiscal stimulus coming out of Congress. So it seems we are in, or will shortly be in a period of stagflation. This is rising prices but low to no growth. This will last at least 6 months, likely more than a year. If the Fed is unsuccessful, we could either go into a recession or experience stagflation for multiple years.

So, in these scenarios, what are your thoughts on investment strategies to generate real returns?

2000cs what is your thesis for the "6 months, likely more than a year" statement? Please explain how you are thinking about this.

What if someone said that inflation has peaked? What would you think about that?

[2000cs]

Originally Posted by chassis

2000cs what is your thesis for the "6 months, likely more than a year" statement? Please explain how you are thinking about this.

What if someone said that inflation has peaked? What would you think about that?

Powell described inflation as “persistent” this week, and the Fed removed any mention of transitory or temporary. That is the basis for the 6+ months comment. Also fiscal policy typically has a lag of at least 6 months (may have been faster with the direct stimulus portion), so there is likely more inflationary pressure to come. However it is possible inflation has peaked, but also won’t fall nearly as fast as it rose (because it takes a while for cost increases to roll through the economy).

On the stagnation side, the Fed’s actions to reduce/control inflation will be recessionary. They will have to walk the line of lowering inflation without tipping the economy into recession - but no doubt growth will be slower.

[2000cs]

On the question of whether inflation has peaked, I would want to look at where prices are up specifically, to judge if they are done or continuing. For example, oil being up means plastics, gasoline, diesel, propane and natural gas will be up. That means any product that uses these as inputs, or for transportation/delivery will be up. This is a cascading inflationary pressure so the oil increases will percolate for some time. Oil, by the way, appears to have peaked, but its effect has likely not.

On the other hand, an increase in finished products, like food and furniture etc, would not percolate except to the extent those increases are so wide-spread that they result in wage increases, and the percolation begins anew.

My sense is inflation has probably either peaked or is near a peak, especially with the Fed focusing on it again. But I think it will remain near current levels for some time as the effects discussed above work their way through the economy.

[DETRoadster]

Originally Posted by 2000cs

On the question of whether inflation has peaked, I would want to look at where prices are up specifically, to judge if they are done or continuing. For example, oil being up means plastics, gasoline, diesel, propane and natural gas will be up. That means any product that uses these as inputs, or for transportation/delivery will be up. This is a cascading inflationary pressure so the oil increases will percolate for some time. Oil, by the way, appears to have peaked, but its effect has likely not.

On the other hand, an increase in finished products, like food and furniture etc, would not percolate except to the extent those increases are so wide-spread that they result in wage increases, and the percolation begins anew.

My sense is inflation has probably either peaked or is near a peak, especially with the Fed focusing on it again. But I think it will remain near current levels for some time as the effects discussed above work their way through the economy.

Raw materials costs are up virtually across the board. My suppliers in China are paying 30% more for stainless steel. Zinc and Aluminum are up 50%. Labor in China is up and until recently production was being held artificially low by mandatory power limits forcing factories to shut down. And this container thing is bullshit. I've got a container worth of product at our factory that's been hanging out on the dock for 2 weeks waiting for a chassis to come pick it up but the port of Yantian is so backed up they are throttling containers coming in. Nevermind the bullshit on this side once the boat actually shows up. We've switched to rail going out of China for our EU customers but even that is seeing 2 to 3 week delays and crippling cost increases. All told our cost to manufacture and ship product is up 30% vs. 2019. We have to pass at least a portion of those costs on. Everyone who manufactures anything and then transports it is in the same situation. I just dont see this as transitory. Not in the next 12 months anyway. There's just too many interrelated variables that all need to chill out before costs and then prices, come back down.

[chassis]

Thanks 2000cs

General comment for the thread - please don’t confuse price level with inflation. They are two distinct notions.

[LookBothWays]

Originally Posted by 2000cs

On the question of whether inflation has peaked, I would want to look at where prices are up specifically, to judge if they are done or continuing. For example, oil being up means plastics, gasoline, diesel, propane and natural gas will be up. That means any product that uses these as inputs, or for transportation/delivery will be up. This is a cascading inflationary pressure so the oil increases will percolate for some time. Oil, by the way, appears to have peaked, but its effect has likely not.

On the other hand, an increase in finished products, like food and furniture etc, would not percolate except to the extent those increases are so wide-spread that they result in wage increases, and the percolation begins anew.

My sense is inflation has probably either peaked or is near a peak, especially with the Fed focusing on it again. But I think it will remain near current levels for some time as the effects discussed above work their way through the economy.

Inflation is like compound interest except in reverse, the principle keeps going up.

[BRAKE!]

Originally Posted by 2000cs

Yesterday Fed Chair Powell officially removed “temporary” from the Fed’s description of inflation, noting that it will be here for a while and that the Fed will use its tools to battle it. Those tools are accelerating the taper and raising interest rates. The taper is likely to accelerate immediately, not clear yet when the first interest rate raise will be.

The Fed’s anticipated actions to throttle back inflation will also reduce growth, which itself was already challenged by supply problems (thus inflation). And effectively the Fed is using monetary policy to fight the fiscal stimulus coming out of Congress. So it seems we are in, or will shortly be in a period of stagflation. This is rising prices but low to no growth. This will last at least 6 months, likely more than a year. If the Fed is unsuccessful, we could either go into a recession or experience stagflation for multiple years.

So, in these scenarios, what are your thoughts on investment strategies to generate real returns?

First, just to share my aspect of the current economic situation - I would say that inflation is here mainly due to the actions taken by the Fed at the start of COVID, where they took unprecedented action to reduce reserve rates for lending (leading to low interest rates that fueled borrowing and purchasing real estate), setting very low reserve requirements for cash reserves held by commercial banks, and gov't stimulus packages - all which pumped a lot of money into the economy to prevent a sudden recession that would've occurred otherwise due to COVID.

So in essence, it created a false sense of profitability and normalcy due to increased volume of money in the economy (as measured by M0, M1, M2).

Consequently, due to the increases in money available, with the subsequent decreases in supply of goods (once again due to COVID causing supply chain disruptions), prices of goods increased due to increased demand. However, inflation also occurred in this situation due to the fact that people actually had money available to pay for the increased prices - and so on and so forth; more money circulating in the economy, inflation kicks in and the purchasing power of the dollar goes down.

The Fed obviously monitors this through the consumer price index which surveys how much a basket of goods an average American family household would buy + (takes into account gov't policies) and then enacts policy to control inflation. Normally speaking, inflation goals are around 2-3% a year. Current inflation rates are > 6%! You can bet the Fed is working to curb this rate at this time.

Recession is never a good thing, but I suspect at some point there will be an economic and market correction. An economy can't have less people working and producing less goods/services, and expect good times to keep rolling.

Rambling aside, to answer your question about investment strategies to hedge against inflation... well if you look at the current P/E ratios of the stock market, the market is extremely overvalued at this time (>2 std dev). Akin to what the market looked like prior to the dotcom burst. Will it burst like the dotcom era? Hope not, but can it sustain returns that we're seeing now indefinitely? History says no. Equities aside, I can't think of one good place to park your money without some form of wild speculation.

I think investing should come back down to principles that work no matter what times you're in - well diversified portfolio that is tax efficient, low-cost, low-turn over that is spread out between stocks, bonds, cash reserves, and possibly, real-estate. I would also emphasize staying the course for the long-term in the stock market, let time be your friend and give compound interest time to do its job. Good luck investing in these wild times.

[chassis]

Good comments @BRAKE!

I see inflation peaking now. I see output of goods and services increasing through the end of next year.

Equity valuation is systemically affected by the interest rate and dividend trajectory for the past 20 years. Low interest rates and buybacks instead of dividends support high valuations. Add a strong economy to the mix and valuations seem reasonable.

When you mention 2 sigma valuations, this needs to be adjusted for interest rate regime (over decades) and dividend-buyback regime. 2 sigma valuation vs history may be the new normal, for good reasons.

Today's investing environment bears little resemblance to the 70s and 80s. A few things remain unchanged: live below your means and stay invested in the market.

Let's talk about transitory inflation: the 10-2 Treasury spread has been anchored near 1% all year. In the past week it has dropped below 1%. This is a general indication of inflation expectations in the future. Inflation will fade away. Prices will not.