Thursday, July 3, 2008

Global Inflation: The New Crisis

A new monster has raised its ugly head to spook investors. Inflation is accelerating at a rapid pace providing policy makers with a new set of ulcers. Unfortunately basic antacid tablets will not cure the unsettled guts of national regulators.

The spike in inflation gives flashbacks to the dreaded 1970s with stagflation era. Many older investors do not enjoy reminiscing about interest rates above 14%, food rising in price each week, investors hoarding gold coins, and long gas lines. The dilemma is that all the statistics indicate that we are heading towards a scenario with run-away rising inflation worldwide.

Regulators have commented on rising inflation, raised interest rates in hopes of moderation, and are shocked to see the numbers running upward like an out-of-control train down the tracks. With rising commodity costs, pent up wage increase requirements, and tightening credit; there is not very much the regulators will be able to do to apply the brakes.

Certainly the news flow has not been encouraging, the ECB raised lending rates today amid record inflation, while U.S. Treasury Secretary Henry Paulson said inflation was becoming the top economic focus of many countries.

Inflation is a global phenomenon; impacting countries as diverse as Iran (with 26% inflation), the Philippines, Brazil, India, Russia, South Korea, Mexico, and Indonesia. No country is immune and no market is safe. Rapidly increasing inflation is the top concern in most nations, and the situation rapidly appears to be heading towards stagflation.

The immediate question becomes how should an investor prepare for this situation? The first emphasis is that a greater portion of your portfolio needs to be placed in commodities and precious metals, or in stocks focused on these industries. There is also a need to have your income oriented investments placed in vehicles which are inflation indexed in regards to interest rates. The other alternative is the keep cash in shorter term CDs as inflation and interest rates rise, allowing an investor to ride the rising curve.

Successful investing in a rising inflationary environment is difficult. Usually the stock market returns are dismal and many other investments are also victims of an inflationary spiral. Still it is best to keep your focus on the long term, and maintain a diversified portfolio of stocks that have wide economic moats. These companies invariably become stronger in downturns as competitors fall by the wayside.

Investors should pay close attention to news about inflation during the remainder of 2008 and start making appropriate adjustments to their portfolio to ride out the storm.


Anonymous said...

Would you still recommend investing in precious metals stocks given that these have already have had a fairly large run-up? Or do you believe that over the next two years we will see an even larger run-up?

GregB said...

It is clear that both oil and precious metals have had a pretty solid run. At this point, there appears to be more upside for both. However I would urge investors to diversify their funds across the entire set of commodities (grains, fuel, metals, etc.). There are several ETFs now avalable that provide this type of diversification with low expenses.

You should not narrowly place your funds into precious metals or oil. Also keep in mind that commodities and/or natural resource stocks should only represent 15% or less of your overall portfolio. However this is the time to go overweight in this investment component.

- Greg B.

GregB said...

For the opposing point of view here is an article from Morningstar that says that investors should not jump into commodity and natural resource oriented investments.

Adding Commodities to Your Portfolio? Not So Fast