Inflation is on the rise. What impact can this have on your investments?



If you don’t see inflation as a threat as much, you’re probably under 40.

Either that or you suspect that the recent upward trend in house prices, rents, food, commodities, gasoline, cars and labor will prove to be fleeting.

The trend could be temporary or even beneficial. Not so long ago, experts were worried about deflation, a more serious threat that slows economic activity.

But too much inflation too quickly is not good either. “What’s clear about inflation is that once this plane takes off on the runway, it’s pretty hard to turn around,” joked Sarah Foster, writer at Bankrate.com.

Older Americans know that an inflationary surge can be difficult to reverse. They remember gas lines from the 1970s, shoppers scrambling for groceries, and other anecdotes from the country’s worst economic decade since World War II.

The current inflationary climate is still not close to where it was then, but it doesn’t hurt to consider the possibilities, especially the possible impact on investments.

Are investments doing poorly amid inflation?

Not necessarily, although much of it depends on the investment in question and the circumstances. During the harsh 1970s, large stocks such as those in the Standard & Poor’s 500 Index averaged below-average returns of 5.9% per year, but small stocks nearly doubled, rising by 11.5% on average, according to researcher Morningstar.

When inflation eased in the 1980s, equity investment surged, with average double-digit returns (including dividends) across the board.

Gold is widely regarded as an excellent hedge or store of value during times of inflation, but prices have weakened lately despite rising inflation. The same is true for other commodities such as copper, although oil prices have continued to rise. Bitcoin and other cryptocurrencies could prove to be hedges against inflation, although the jury is still out. Yields on treasury bills, bank deposit accounts, and the like also tend to rise during times of inflation if interest rates also rise, as they often do.

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One of the main reasons that stocks can thrive in an environment of low inflation is that companies, especially large ones, can often pass on cost increases. Nick Colas, co-founder of DataTrek Research, believes capacity is more apparent today due to heavy investments in technology that have given companies a better edge in managing expenses and knowing the pass-through of those costs. .

Gradual changes are less worrying

Stocks and even bonds, to a lesser extent, can generate decent returns during times of inflation. Investors tend to tolerate inflation as long as it doesn’t come in big waves.

Over the past decades, overall stock returns have been fairly consistent – ranging from around 11% to 15% per year, including dividends – whether inflation is high, low, rising or falling, according to a study by JPMorgan Funds. One caveat, however: the results were compiled from 1988 to 2020 and therefore reflect a period when inflation was fairly stable, averaging around 2.5% per year. He didn’t measure the impact on stocks when inflation rose more wildly, like in the 1970s and early 1980s.

The study also found fairly consistent results for bonds over this 33-year period, with yields (including interest payments) clustered between 5% and 9% per year, regardless of the inflationary environment.

However, bond prices can fall sharply if interest rates rise. For example, a one percentage point jump in the general level of interest rates would cause a price loss of around 20% on 30-year Treasuries. Bond yields or interest payments would cushion the blow only to a limited extent.

Lower-rated bonds could hold up better in a rising rate environment than those issued by governments. This is partly because they pay higher returns, and partly because their values ​​are more closely tied to credit risk factors.

What about real estate?

Like gold and stocks, real estate, including housing, is widely viewed as a hedge against inflation. “In the 1970s, when consumer prices were rising on average over 7% per year, median new home prices were rising over 9% per year,” wrote David Kelly, chief global strategist for JPMorgan Funds.

Inflation is also linked to mortgage rates and therefore to the affordability of homes. Expectations of future inflation help push up interest rates, including those on 10-year treasury bills, to which long-term mortgages are attached.

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Mortgage rates tend to be around 1.75 percentage points higher than the yield on 10-year T-bills, observed Lawrence Gillum, fixed income strategist for LPL Financial, although the spread has narrowed in the latter. time. This 1.75 point difference is a “rough estimate of the costs associated with obtaining a mortgage,” he said.

Gillum expects the 10-year yield to end in 2021 between 1.75% and 2%, which could push 30-year mortgage rates up to around 3.5% or a little higher. Earlier this year, 30-year mortgage rates hit a low of nearly 2.8%. They are currently around 3.2%.

Put into perspective

Although inflation is gaining more attention this year, it is still far from what it was in the 1970s and early 1980s. Inflation averaged 7.4% per year over the years. 1970s. It reached 13.3% in 1979 and 12.4% in 1980.

Since then, the Federal Reserve’s efforts to contain inflation have worked. So are trends like America’s aging (older people don’t buy as many cars, appliances, etc.), technological innovations (computer prices have fallen), the rise soaring cheap foreign imports, etc. In recent years, inflation has mainly hovered around 2%, although it reached 5% in the last 12 months, until May 2021.

The prices of used cars and trucks have been significantly higher in recent times. The same goes for gasoline and airline tickets, the Bureau of Labor Statistics reported. But the price changes were more moderate for other goods and services, including health care costs.

The future course of inflation is perhaps the most debated topic in economic circles today. Some observers anticipate a new era of higher price points, but others view the recent rise as temporary, reflecting “reopening luck” for businesses from the coronavirus pandemic. As the business climate returns to a more normal base, they expect inflation to return to the level.

Contact the reporter at russ.wile[email protected].

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