Market Update: The Other Tax

Consider these two perspectives on the current economic climate:

“We are seeing substantial inflation. We are raising prices. People are raising prices to us and it’s being accepted.” -Warren Buffet, CEO of Berkshire Hathaway (May 2021)

“I don’t think there is going to be an inflationary problem. But, if there is, the Fed will be counted on to address it.” -Janet Yellen, US Treasury Secretary (May 2021)

The Long Tail of COVID

How can two Americans in leadership roles influencing millions of citizens see the US economic environment so differently? Buffet, as an investor, wants to be able to justify the price increases his customers are seeing. Yellen, as a government employee, must align herself with the federal government’s position on spending. While there are differing perspectives on our economy in recovery, let’s sort through the noise.

Inflation has been talked about for several months, and with everything from gasoline to bacon going up in price, people are paying attention. The ISM Services Index illustrates these price increases: the price gauge rose to a 13-year peak and is twice as high as it was in February 2020. Yet the Federal Reserve bankers and others say the price increases are transitory and will not last. 

There are two possible options. The Fed can either take an active stance and correct the inflation seen in the wake of COVID or wait and see. A correction means tightening monetary policy: hiking interest rates and ending quantitative easing by buying bonds and increasing the money supply. The proposed stimulus programs produce a quandary for the Fed; while they want all that was initially promised, financing it could be inflationary.

Inflation is more than an expansion of the monetary supply and the resulting increase in consumer prices. At its base level, it is taxation. The government has two ways to pay for expenses: direct taxation, where income taxes come out of your pocket; and printing money, which can lead to inflation. Today the Fed is attempting to balance recovery while avoiding an economic slump.

For investors, the key takeaways are: 1) We are seeing some inflation as the economy repairs itself in the wake of the pandemic, 2) this phenomenon could be short-lived, but 3) if it does persist there are ways to reduce your exposure to inflation’s effects.

Minimize the Effects of Inflation

1. Invest in stock. Stocks have historically outperformed inflation. Invest in sectors that may benefit from rising prices such as food, tech, construction, or energy. Companies that can adjust prices without giving up market share and without investing additional capital can do well in an inflationary environment.

2. Invest in diversified commodities. Diversified commodity funds allow you to invest in hard assets that increase with inflation. The pandemic disrupted supply chains globally and returning to normal requires a heavy hand in primary commodities. A diversified fund that includes holdings in crude oil, corn, precious metals, and others diminishes the risk of holding a single commodity.

3. Buy a rental property. As interest rates go up on mortgages, we may see a collapse in the housing market. Consider income-producing properties as an alternate revenue stream, where monthly rent is received as passive income. If inflation takes hold landlords can raise rents to offset the impact.

4. Invest in guaranteed stable value instruments. When interest rates go up bond values go down. Stable value instruments guarantee your principal will not go down, as the instrument will pay the higher rate on new contributions.

5. Dot your “I’s”. I-bonds are inflation-protected bonds issued by the US Treasury that can help you earn an inflation-adjusted return risk-free. Your purchasing power is never diminished. Alternately, consider international investments for broader opportunities to further diversify your portfolio.

Inflation cannot be completely avoided, but you can be prepared for it. A CERTIFIED FINANCIAL PLANNER® can prepare an investment strategy for you.