How will soaring wages and labor shortages affect your portfolio? It depends on how your portfolio is allocated. If you’re heavily allocated towards equities, you may be in trouble.
Creeping inflation is a big concern for 2021. Even the Fed has expressed caution. So far, inflation has been passed on to the consumer who, replenished with stimulus checks, has just accepted higher prices as a way of life – because they can afford to.
But, what happens when they can no longer afford to?
Add to inflation fears, soaring factory prices in China. Long a source of cheap goods, China is now exporting higher prices because consumers are willing to absorb them – for now. On June 9th China reported that factory-gate prices rose at an annual rate of 9% in May, the highest in more than a decade. That, along with soaring shipping costs and a stronger yuan, will probably push up the prices of made-in-China goods.
How serious is inflation?
This week, Deutsche Bank warned of a global ‘time bomb’ coming due to rising inflation – emphasizing that it’s a problem that can’t be ignored or go away. Deutsche Bank expressly pointed its finger at the Fed, warning that its newfound policy of minimal intervention against inflation to sustain job growth is a recipe for disaster. The fear is the Fed will decide to step in when it’s too late.
Should investors be worried about inflation? Absolutely, especially investors heavily allocated to equities.
Here’s how soaring wages, labor shortages, and soaring factory prices affect your portfolio:
Inflation can ruin portfolios in one or more ways. Suppose your retirement is concentrated in a 401(k), mutual fund, or stocks. In that case, inflation will eventually diminish your portfolio value, and the Fed may not be able to save investors this time.
In the past, in the face of creeping inflation, the Fed will typically take pre-emptive steps before prices get out of control and turn into hyperinflation. Its go-to weapon of choice for battling inflation has always been to increase interest rates to slow the economy. It’s a page out of the “ounce of prevention is worth a pound of cure” playbook. The logic is that some short-term pain will be worth avoiding the long-term damage from hyperinflation. Hyperinflation is no joke. Imagine paying $20 for a loaf of bread in a year but without a rise in income.
By raising interest rates, the Fed’s objective is to slow growth and rising prices. When combined with higher input, production, and labor costs, increasing the cost of borrowing all have the effect of slowing economic activity. The problem is that as bottom lines decline, so do stock prices. Declining stock prices means diminishing 401(k)s and IRAs heavily allocated to mutual funds.
As recently as the Great Recession and the stock market crash precipitated the decline, near-retirees saw their 401(k)s drop as much as 50%. Imagine having only half of what you planned for retirement? Many retirees who had planned to retire in 2008 were forced to work in 2008 and beyond.
Inflation is here, and it will devastate your portfolio if you ignore it. Can you stop inflation? No, but you can stop it from destroying your portfolio. How?
You can shield the effects of inflation the way savvy; wealthy investors have been insulating their portfolios from inflation for years: by investing in demand – demand for hard assets that thrive in any economic environment.
What are examples of these types of inflation-resistant hard assets?
You might be able to answer this question yourselves by thinking about demand. What goods or services will consumers always need – good times or bad? Food and shelter are obvious examples. So are clothing and fuel. These are all essential assets.
Investing in essential assets – assets that will always be needed and in demand – will be the best antidote against toxic inflation.
Investments in essential assets that can generate both inflation-resistant cash flow as well as appreciation that can keep up with rising prices will provide the protection your portfolio needs that equities can’t offer.
If you can accept that inflation is here and take the necessary steps to protect your portfolio, you will be able to weather the coming storm better than most.
Hedging against inflation by investing in essential assets – assets with a demand that will thrive in the face of inflation will be your best bet for survival.
