10 Inflation Defense Ideas For Your Portfolio

Continuing on a theme from last week, I have researched some more investments that would perform well in the event we see a big uptick in inflation in the coming months and lasting for the next few years.  

Inflation would be generally bad for stocks, since a lot of the recent increase in stock valuations has been driven by extraordinarily low interest rates and inflation will drive longer-term rates up.  Essentially, bonds are not a good investment with such low rates and negative real yields, so investors for the most part have been forced to sell bonds and move into riskier assets like stocks for better returns, creating a virtuous cycle and strong stock market rally for the last 11 months, with a few minor pull backs.  

With persistent inflation however, bond yields would eventually climb to a level that would attract more investors away from stocks and looking for "safety."  Some have said that could happen when the 10 year Treasury approaches 2.5% or 3%, (assuming no Fed intervention) which would also put a damper on economic activity, including housing and autos which have been leading the recovery so far.  In past periods of high inflation (i.e., the 1970's), the stock market traded flat, while commodities performed really well.  As I have written previously, we have seen an unprecedented growth in the money supply due to the Fed cutting rates and buying bonds - about $5.7 Trillion committed.  The money supply curve has gone parabolic (see chart below).  

We have also seen unprecedented monetary stimulus from the Federal government ($4.8 Trillion committed between Legislative and Executive actions so far) with more on the way ($1.9 Trillion current proposal which seems likely to pass largely in the form it was proposed and infrastructure proposal promised to follow).  Here's an interesting summary I found on the total amount of COVID support outstanding - it's staggering.  Both of these forces seem likely to result in a very strong economic recovery, which will ultimately lead to higher inflation.  Once inflation gets started, it will be difficult to get the "genie back in the bottle" without hurting the economy with higher interest rates.  Interest rates are headed up (chart below shows the 10-year Treasury yield, an important benchmark that impacts housing and commercial loans), with the recent increase likely due to inflation expectations - currently at 1.16%.  This is still low by historical standards and so not a concern yet, but we'll have to see how the next few months plays out.

Inflation as expressed by the Consumer Price Index continues to look tame as shown in the chart below, showing a 1.4% increase in January 2021 vs a year ago, but of course the long term perspective is that purchasing power of the dollar is eroding steadily over time.  You can also see the big increase in inflation during the 1970's on this chart where the price index doubled from 40 to 80 or 100%:

If you invest in 10 year Treasuries at 1.16%, you are earning a negative 0.24% real rate of return after inflation.  That's troubling enough.  However as I have written before, there are many issues with how the Consumer Price Index is calculated, particularly that it excludes housing, food and energy costs (due to their volatility), but as everyone knows all have been increasing steadily recently.  Also, the way the index is calculated has changed over time and has not been consistent.  The real rate of inflation could be closer to 10%, as shown in the chart below.  That really changes the math of the real inflation-adjusted return on Treasuries - a negative 8.84% real rate of return.  No wonder Bitcoin is so popular.

Here's my list of 10 ideas for inflation defense (you can spread across all ten equally weighted or pick and choose which ones make the most sense for your portfolio):

1. BlackRock Resources & Commodities Strategy Trust (BCX) - actively managed commodity closed-end fund that invests primarily in common stocks of miners, chemical companies, oil companies and other basic materials companies; 6.13% distribution yield and currently trades at a small discount to net asset value

2. Freeport-McMoRan (FCX) - copper and gold miner; pays a dividend but very small yield

3. SPDR Gold Trust (GLD) - no yield, just exposure to physical gold

4. Barrick Gold (GOLD) - gold miner; 1.38% yield and Warren Buffet likes them

5. Sprott Physical Silver Trust (PSLV) - no yield, just exposure to physical silver and said to be better than SLV

6. Rio Tinto (RIO) - diversified mining company (Iron Ore, Aluminum, Copper/Diamonds - includes gold, silver, molybednum, Energy/Minerals - includes uranium, borates, salt, titanium dioxide and coal); 4.61% yield

7. ProShares UltraShort 20+ Year Treasury ETF (TBT) - 0.3% yield, this is a 2x inverse long term US Treasury ETF; if interest rates on longer-dated treasuries continue to climb with inflation expectations/reality, the fund's value will increase

8. Vanguard US REIT Fund (VNQ) - diversified ETF representing market-cap weighted index of entire US REIT market - real estate has historically benefited from inflation since financing costs are generally fixed for extended periods of time, operating cost controls are generally very good and  rent income tends to move up with inflation; 3.89% yield

9. Vanguard Short-Term Inflation-Protected Securities ETF (VTIP) - tracks an index of Treasury Inflation Protected Securities with 5 years or less remaining to maturity; 1.19% yield

10. Vanguard FTSE Emerging Markets Fund (VWO) - tracks a market cap weighted index of emerging market stocks - weak dollar resulting from inflation will be a boon for emerging markets; 1.77% yield

I may make some of these moves, but not for a few months until I can see a bit more confirming evidence that inflation is indeed on the move.  This is intended to be a buy and hold, multi-year strategy.  I think we will have pretty good confirmation of where inflation is headed by this summer.  Before investing, make sure you do your own research, consider what others have to say and make your own decisions.  Also make sure to look at your overall portfolio diversification regularly.  

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2021.  To see all my books on investing and leadership, click here. 

Stay safe, healthy and positive.