Hi everyone. Welcome to the Podcast and thank you for tuning in. I’m here with Evan Shorten, the firm’s founder and principal.
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So today we want to revisit the topic of investing during inflation. We last covered this topic back in July of 2021, however the economic and financial landscape around the world has completely changed. To give you an idea, last year around this time interest rates were between 0-0.25%; Jerome Powell and the Federal Reserve were telling us inflation was transitory and not a concern; The S&P 500 seemed to be hitting new all-time highs every month; and the U.S. was nearing the end of its troop withdrawal from Afghanistan.
One year later, and the world looks a lot different. Interest rates are between 1.50-1.75%; Jerome Powell and the Federal Reserve have made an open commitment to fight inflation; The S&P 500 has hit bear market territory; and a war between Ukraine and Russia has resulted in commodity shortages around the world which may impact grocery store shelves for some time.
With such drastic changes taking place from one year to another, it’s our job as investors to adapt and modify. If you’re sort of scratching your head right now, trying to figure out the new landscape, this podcast should hopefully give you something to think about; or perhaps you might find it better to work with a professional to help you navigate the current landscape.
Evan, what are some of the ways investors could sort of inflation-proof their portfolios?
Well first off, I need to remind everyone, we don’t give investment recommendations or provide financial advice on our podcast. The podcast is supposed to be informative and give you ideas and concepts to think about – nothing more. That said, if you would like to contact us directly to discuss some of this topic in more detail, please don’t hesitate.
With that said, I think bonds as an asset class are being overlooked at the moment. Conventional wisdom tells us that as interest rates go up, bond prices go down in value. While that may be true, it only applies if you sell a bond before its maturity date. If you hold a bond until maturity, you still receive the full par value. I’m now seeing new bond issues that are starting to provide investors with yields that we haven’t had since before the 2008 financial crisis – especially at the shorter end of the spectrum. For example, the 2-year treasury is now approximately 3.2% compared to near zero a year ago.
If the Federal Reserve keeps raising interest rates as it claims it will, new bond issues are going to reflect those higher rates and become even more attractive to investors.
So it seems that fixed income may make a comeback in the end.
It’s definitely a real possibility and with yields rising on the shorter end of the yield curve, it could present interesting opportunities to ladder the bond portion of a portfolio.
Ok, what else?
In July of 2021 we discussed energy and oil, specifically oil stocks as looking very attractive. At the time energy and oil stocks were just starting to recover from multi-year lows. While the sector has certainly had a good run this year, I think there is still opportunity. If the conflict in Ukraine and Russia continues, we’re going to have prolonged oil shortages, meaning higher margins for the energy sector as prices continue to rise.
I know there are a lot of narratives towards ESG and a transition towards clean energy, but the reality is the dependence on oil around the world isn’t going to disappear anytime soon. Oil is a component in too many products such as plastics, asphalt, wax, deodorant, soap, and so on.
Another asset class that gets a lot of attention during rising periods of inflation is real estate. What are your thoughts on real estate now that we’re dealing with both inflation and rising rates?
Real estate can be tricky right now due to rising rates. Additionally, real estate as an asset class is very broad. The asset class actually behaves very differently between commercial, residential, multi-family, single family, industrial, student housing, etc.
If you can allocate towards multi-family real-estate, meaning apartment buildings, that could be a very good place to hedge against inflation. You’ll have the ability to increase rents as your costs of maintaining that property go up. Multi-family housing can also be very stable during periods of high volatility when you’re trying to preserve your wealth. Unlike a stock or mutual fund, the value of your multi-family real-estate is based on what’s called the “rent roll,” or the collected rent. It’s not as susceptible to movements in the market like individual stocks or mutual funds.
The key is to take a value oriented approach to a hot inflationary environment, such as seeking out opportunities with increasing cash flows.
Ok and actually, speaking of real-estate I want to piggyback off that and mention one of the best inflation hedges ever created; and that’s the 30-year fixed mortgage.
Yes, your mortgage is your greatest protection in the fight against inflation. Even with mortgages being significantly higher this year than last, a 6% mortgage rate is still a good inflation hedge. To give you a quick comparison, Realtor.com reported that rents across the US went up by 10.1% through the end of 2021 with the 50 largest metros experiencing 19.3% increase in rent prices.
While not all parts of the country experienced the same rate of rental increases, it illustrates how locking in your housing cost for a 30-year period is the best inflation hedge you can make. 20 years from now, you’ll still be making roughly the same mortgage payment, while a renter may be paying multiples of the current rent they pay today.
One last investment that I want to mention for periods of rising rates and rising inflation is business or entrepreneurship. Entrepreneurs have a lot of flexibility with their income. For example, an entrepreneur can often reduce their tax liability in some years by investing more into their business. Business as an asset is unique in that the tax man actually rewards you for making additional investments. Additionally, an entrepreneur can mitigate some of the inflationary pressures by adjusting their prices. Lastly, an entrepreneur is rewarded for their success. An entrepreneur who can grow their business, perhaps cut expenses or streamline their process, and increase profits while reaping the increased financial rewards.
I know entrepreneurship is not for everyone. There is nothing passive about this asset class and you’re concentrating your wealth heavily into a single asset, but if you can find success with it, you can offset the wealth robbing effects of inflation throughout your lifetime.
Ok, I hope this episode gave you something to consider. I know we talked about a few different items related to hedging against inflation and not all of those items pertain to everyone. However, please bear in mind our clients and target demographic may at times be in the position to invest in assets beyond a stock and fund portfolio and our podcast is here to serve as a place for potential ideas rather than provide a how-to.
If you enjoyed the podcast or found some value in the content, we ask that you please subscribe so you can listen to our future episodes. If you’re worried about inflation, your portfolio, or looking for some guidance, please don’t hesitate to contact us.
Thank you for listening and we’ll see you here next time.
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