It’s been a volatile week. For the better part of six months, investors haven’t seen a material pullback like we are seeing right now. Several newsletters ago (available only to clients), I stated “a strong recover is likely, but we can’t rule out a market correction on any potential negative catalysts.” It seems we now have that catalyst in the form of a spike in inflation.
Let’s put this in perspective so we are all on the same page.
Wednesday’s Consumer Price Index (CPI), the widely accepted measure of inflation, came in at 0.8%, the highest in 13 years and was much higher than the 0.2% predicted. This pushed the year-over-year number to 4.2%, much higher than the 2.6% from March’s reading. But we have to take this in context…what was happening in March/April 2020? You guessed it, lockdowns.
Since then, we’ve seen massive amounts of stimulus, a 25% increase in the M2 money supply, a 2×4 piece of lumber almost double in price, housing values significantly higher, and extra unemployment compensation that’s causing a labor shortage and price increases. Are we really surprised by a spike in inflation?
So if it was kind of expected, why are the markets acting like an angry toddler? In my opinion, markets were overextended from the past several months of rallying. Any negative catalyst that could imply the Fed tightening monetary policy sooner than they’ve stated was enough to cause this pullback. Recall the Fed “not even thinking about thinking about raising rates?” Yeh, they may consider “thinking about it” now if next month’s CPI reading runs even hotter. In my opinion (and history is on my side), raising rates gradually, methodically, and transparently is far better for markets than trying to chase higher inflation with drastic increases to control it. The latter typically causes a recession. Being proactive is the key here and I certainly hope Powell & Co. (slang for The Fed) are smarter than me.
Am I allowing this to change my clients’ investment strategies? A resounding, no. These past few weeks have seen an increase in selling on the growth/tech side of the style box and buying on the value side. This has pushed value stocks higher and my clients have benefitted from this. Even during broad market down days, we see the value side perform less-badly than growth. Why are we positioned this way: Our Investment Philosophy.
Should we add inflation hedges?
The best long-term inflation hedge is equity exposure, in my opinion. Even during these short-term bouts of volatility, equities are typically the best bet. Other inflation hedges are Treasury Inflation Protected Securities (TIPS) and ultra-short bonds for conservative clients. Real estate exposure and commodities (gold, oil, raw materials, etc.) are hedges as well. But none of these have the long-term track record that equity exposure provides. Since my clients are globally diversified, most of them own all of these already. I can’t make a case for timing our way into and out of concentrated positions specifically to hedge against inflation. Recall that we aren’t traders, we’re investors.
Higher inflation is a drain on purchasing power. So too are higher taxes. Both of which we are likely facing in the coming year. These questions remain:
- How “hot” will inflation run before Fed intervention?
- How much will taxes actually increase under President Biden’s proposal?
- What other catalysts are we likely to face through the fractured reopening of America and the world?
For clients of Coastal Wealth Advisors, I monitor this information, among many others, daily and keep clients informed of issues relevant to their invested dollars, like inflation surprises. We maintain a passive approach to our investment philosophy, but an active approach to monitoring and rebalancing as needed. Monitoring is the final step of the financial planning and investment management process. It is in this phase of the process where I believe value is created. It’s crucial to be in contact with your advisor often. When’s the last time you heard from your advisory team? If your answer is more than a year, let’s chat. I believe there’s a better investment experience waiting for you. Get in touch here.