It appears to be the investor question or fear of the day. Are we in for a bout of high inflation? Is another round of the 1970’s style (energy shock inspired) stagflation a possibility? The U.S. government has signalled that the war with Iran may likely continue to the end of their term through 2029. Higher energy costs can leak into the broader economy. And of course, surging bond yields have grabbed the attention of investors and portfolio managers. The good news is – nobody knows how this plays out. So let’s look at what worked in the 1970s, what works to fight inflation, and what might work again. You can learn how to be prepared.
As always the following is not advice. These are ideas for consideration as you build and manage your portfolio.
The topic of inflation and portfolio construction is not new to you if you’ve been reading this blog for many years. Here’s a recap / reminder –
How to protect your portfolio against inflation.
The dedicated inflation fighters are well known. Gold, commodities, energy and infrastructure and commodities stocks, real estate. They will fall under that category of ‘real assets’. You can’t print copper as they say.
As per the above post, Canadians looking for a one-stop inflation-fighting shop can consider the Purpose Real Asset ETF – PRA-T.
It can be feast or famine with commodities
This is a good time to remind you that commodities can be very explosive (to the upside) during times of high and unexpected inflation – ditto for gold. But they can stink the joint out during periods of low to modest inflation, and disinflationary times. Given that, you should give careful consideration to whether you want or need to hedge higher inflation or stagflation. We should understand the risks.
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Equities typically don’t mind modest inflation, even higher than what we are experiencing today. From this Kiplinger post.
“As Ben Carlson of Ritholtz Wealth Management showed on his Wealth of Common Sense blog, the U.S. experienced 17 periods of 5.7% or higher inflation from 1928 to 2020. “The average returns for the S&P 500 in these years were 9.4%,” Carlson says. “That’s basically the long-term average over the past 90-plus years.”
Keep in mind Ben is not accounting for real inflation adjusted returns in his analysis –
Obviously, those returns were lower on a real basis after accounting for the higher inflation. But it’s not like it’s a total disaster for stocks when inflation runs hot.
Well, not really. Equities don’t like inflation shocks and extended high inflation such as what we experienced during the late 60’s through the 70’s stagflation period. These are rare events, but risks to considered. According to testfolio here’s the real returns for the S&P 500 through the stagflation period …
From Gemini, a look at moderate inflation periods. Stocks typically can perform well during these periods.
The direction of inflation matters for the above as well. If inflation is accelerating, stocks perform more poorly. If inflation is decelerating, stocks can perform well. The markets are thinking/guessing the worst is over. Stocks like low inflation and disinflationary times – what today’s investor is most familiar with. We also think that is “normal”.
Inflation is totally unpredictable
But once again. No one knows where inflation will go.
This graphic from macrotrends shows that inflation has hinted it is going higher at times, and the threat faded.
Remember the debate and fear of a inflation in 2021 and into 2022. The argument was that inflation would be quick and ‘transitory’. It was more sticky than most predicted. Though eventually inflation came down and rates (bond yields) went along for the ride. Here’s Canadian inflation – 10 year table.
Bonds and inflation
Bond yields are rising globally because investors are demanding more compensation for persistent inflation risks, massive government borrowing and a growing flood of corporate debt — including the enormous sums being borrowed to build out artificial intelligence infrastructure.
Be sure to read – Stocks are the unruly kids. Bonds are the adult in the room.
On fixed income we should remember that inflation is cryptonite for longer dated bonds. But ultra-short bonds (cash) are a decent hedge against inflation. Yields rise in tandem with the ongoing rising rates. At times the yields are enough to cover high inflation. On Twitter / X this week I shared this chart.
IEFSIM is 10-year U.S. Treasuries, CASHX is 0-3 months Treasuries (cash), SHYSIM is the 1-3 year Treasuries. The returns are inflation-adjusted through the stagflation era. We can see that longer dated bonds lost considerable value. Cash and short term bonds traded places through the cycle as the best option.
Learn how to manage inflation in retirement.
And here’s a startling chart. Many have suggested that bonds move in a 60-year cycle. 30 years down, 30 years up (in price). Remember bond prices offer an inverse correlation to rates. Rates go up, bond prices and bond values go down. The longer the duration, the greater the price risk.
Are we headed for another 25 years of a rate increase cycle? See the headline of this post. Who knows? The important point is to understand that it is possible.
This is a good take. In each cycle we think it’s permanent while we are inside it. We have a rinse and repeat recency bias.
What does it all mean?
Once again, it is a personal decision to hedge the high inflation / stagflation risk or not. Purpose PRA.T has risen to the occassion once again, with the increasing risk.
From July 1, 2026 it’s up a whopping 12.5%.
My take is that accumulators with over a decade to go might ignore these risks. You can dollar cost average through any volatility on equity prices and inflation. Retirees and near-retirees might consider using a dedicated inflation hedge.
I’ve offered many ideas on inflation risk management in the above post links. Here are a few more ideas for consideration; once again, not advice.
Berkshire. A lower risk way to manage stagflation risk?
One stock that we hold that I really like for most any period is Berkshire Hathaway BRK.B. While it’s held in my wife’s U.S. Dollar RRSP, it is our largest holding by a considerable amount . The company performed very well during the stagflation era, and many analysts suggest that the company is just as well situation today (to handle a bout of ongoing rising inflation).
Berkshire owns a lot of real assets including Berkshire Energy. Chat GPT offered …
Sector inflation-fighting hat trick
You might look to State Street’s Global Natural Resources ETF. It provides exposure to a number of the largest market cap securities in three natural resources sectors – agriculture, energy, and metals and mining. That is a U.S. Dollar ETF.
Diesel prices spike to record highs
In mid September rising diesel prices appear to present the greatest threat to inflation. Diesel is at record highs. While a spike in regular gasoline costs strains a consumer’s discretionary pocketbook directly at the pump, a diesel price spike acts as a structural tax on the entire global supply chain. Because diesel powers the industrial core—including freight trucks, cargo ships, trains, agricultural tractors, and mining equipment—it is upstream of virtually every physical good.
We can own the U.S. and global refiners by way of this ETF with a clever ticker – CRAK from VanEck. Also, you can gain refining exposure by way of the oil supermajors such as ExxonMobil, Chevron, Canadian Natural Resources, Suncor, Imperial Oil. Parkland is another Canadian refinery play.
I will be looking to sprinkle in a few of these refining names, with charts that look like this …
I will be going over a few of the candidates at Wealth Club.
Thanks for reading. Please offer your thoughts in the comment section. How are you managing inflation risk? Or perhaps you are sticking to your core investment strategy.
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You can also join us at Retirement Club for Canadians. It’s most everything you need to DIY your retirement. The Retirement Club offering …
The sensible advice route
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