Don’t Let Inflation Stagnate your Gains
Inflation remains one of the biggest worries for sentient investors. Not many investments perform well during times of inflation. Here’s why:
Interest rates tend to rise with inflation resulting in lower bond prices. If the 30-year rate rises by just one point to 3%, who will pay full price to lock in 2% for 30 years? The 2% bond’s price declines approximately 20% under that scenario.
Why inflation stinks
Even if interest rates and bond prices never change, investors never pay tax and never make a single withdrawal, their 2% bond interest income will still lose to inflation.
Many other investments have difficulty holding their own with inflation. Even basic commodities can produce subpar returns as few investors can both buy near the absolute bottom and sell near the top.
What should I focus on?
While stock indices may outperform other asset classes, they can still lose to inflation. Underneath the widely followed stock indices, some stocks will have horrid performance and others will shine. See our thoughts on investment traits that generate stronger returns (we won’t sell your information).
Investment traits that generate stronger returns:
-
- Income – recurring and growing cash dividends
- Sector – energy, financials and materials
- Quality factor – excess cash generation
- Balance sheet – well-laddered fixed rate debt
- Market – few competitors, economies of scale, barriers to entry
- Product – unique & value-added vs substitutable
So what do I do?
Even better than applying broad market screens, investors should dive into each company. Do managements return phone calls? Have their presentation tone and reasoning recently changed? Are they consistent and reliable? Do they have a history of disciplined decision making? How has management prepared for inflation? What steps are they currently taking in this regard? Are they ahead of inflation or well behind?
Many firms cannot fully offset rising inflation costs. They cannot raise the prices of their goods and services enough due to competition and product substitution. For the first time in the internet era, many firms will try to dramatically raise prices. Consumers and competitors have more pricing information today. As firms fail to raise prices fast enough to preserve profits, their stock prices should decline.
We can help in these market conditions
We have prepared for this environment. We invest in firms with pricing power, leadership in growing niches, economies of scale, innovation, strong barriers to competitive entry and excess cash generation. Their cash can be used to reinvest in growth, buy competitors, directly reward shareholders and/or retire debt as it comes due.
In almost any economic environment there are winners and losers. We’re excited about the future for each company in our portfolios because we’ve put in the research. Let us help you reach your goals.