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What Assets do Well in an Inflationary Environment?

What Assets do Well in an Inflationary Environment?

May 04, 2022

I will mention just a few here, without trying to create the ultimate list:

  1. Commodities
  2. Treasury Inflation-Protected Securities (TIPS)
  3. Floating rate bonds—I include this one simply because of close the relationship is between inflation and interest rates.

Part of the issue that you run into here, and this is particularly why stocks, or even specific sectors, are not listed, is that even though a company might experience a revenue increase after raising prices, that is often offset, at minimum, by an increase in the company’s expenses.

As a result, profit doesn’t necessarily increase when revenue might. Further, as was previously stated, when limited resources go toward one company in increasing amounts, it will eventually and inevitably lead toward fewer resources going toward some other company, which would lead to a decrease in the second company’s revenue.

Are there any assets that should be avoided in an inflationary environment?

I would place the focus simply on any interest-bearing asset of a long-term nature. The reason for this is simple as well: because of the correlation between inflation and interest rates, any investment that handcuffs you to a lower rate, relative to what’s most likely to come, for a long period of time, prevents you from being able to easily redeploy your funds to take advantage of higher rates. I would highlight long-term bonds and certificates of deposit (CDs), here, as well as annuities with longer surrender periods.

Something to know about bonds, in particular, is that their value is impacted by changes in interest rates. Bond values have an inverse relationship with interest rate changes. This means that decreases in interest rates, which we have basically seen since the mid-1980s, result in bond value increases, while increases in interest rates, which we are primed to experience, result in bond value decreases. Generally speaking, bonds with a longer term to maturity would be the most susceptible, but the susceptibility of a bond is captured in something called duration, and that is not exclusively a function of time to maturity.

Moving Forward

The advice that I would have for investors would be two-fold:

  1. Prudently adjust strategies and allocations now, based on the current uncertainty—don’t wait until the consequences of that uncertainty set in, and are confirmed by, markets entering bear market
  2. Have faith in your strategy—it’s been adopted for a reason—but remain flexible and open.

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