Here’s How Inflation Can Affect Your Portfolio

Annual inflation in the US accelerated to 9.1% in June 2022, the highest point in more than 40 years, and saw the fastest price increase since Nov 1981. Although inflation declined to 8.3% in August, we are likely to continue upward pressure on most prices for the foreseeable future.

But despite the current environment of falling stock prices and skyrocketing inflation rates, some assets are well positioned to benefit. For example, farmland often performs well in inflationary environments and enjoys leaps and bounds in both land valuations and commodity prices. Historically, farmland yields have been about a 70% correlation with the CPI. Let’s take a look at the factors driving prices up and how these past trends have affected some of the best asset classes.

Related: Inflation Is A Risk To Your Business, But It Doesn’t Have To Be A Bad Thing

Factors fueling inflation

As a result of strongly stimulating the economy during the Covid-19 pandemic, the M2 money supply increased by about 40% from March 2020 to June 2022, while the M1 money supply grew 5x. This influx of money into the economy helped push prices to their 40-year high; goods like food cost now 10.4% more than a year ago.

Shipment delays due to lockdowns, staff shortages and slow port turnaround times are causing ongoing delivery restrictions worldwide. In turn, consumers are confronted with higher prices due to passed on costs and scarcity of inputs. For example, although they are starting to fall, fertilizer prices are increased 80% in 2021; earlier this year, prices rose another 30%.

The war between Russia and Ukraine is increasing inflationary pressures, especially on world food prices. Russia and Ukraine are major suppliers of raw materials, especially commodities such as wheat and corn; combined, the two countries export about 25% of the grain of the world. Due to sanctions against Russia and transport challenges within Ukraine, only a fraction of this supply has been accessible to the rest of the world. As a result, wheat prices rose by 37% in the first two months of 2022, while maize prices increased by 21%.

While every inflation period is different, the historical performance of some of the best asset classes can indicate how each of them might trade in the current environment. Let’s take a look below at how inflation can affect some of these major asset classes:

Shares

In general, real returns of stock prices are falling when inflation rises. In fact, from 1979 to 2021, public equity returns were significantly lower when inflation was low more than 4.1%. This performance is driven by higher prices for inputs, causing many companies to experience lower profit margins. In addition, a stricter monetary policy discourages borrowing because of higher costs.

However, some stock market sectors tend to benefit in times of inflation. For example, rising oil and other commodities prices have resulted in energy sector stocks making record gains in 2022; the Energy Select Sector SPDR Fund (XLE) is up 42% this year.

bonds

Tighter monetary policy in response to inflation has historically negatively impacted fixed income. When the Fed raises interest rates, as we see today, bond prices fall as yields become more attractive. As a result, the correlation between stocks and bonds gets the strongest during long periods of high inflation, which can also cause bonds to lose their diversification characteristics. This can amplify volatility, especially for investors who rely on a “60/40” portfolio.

Related: 4 Ways to Protect Your Business from Inflation

Property

Historically, inflation and house prices tend to move in the same direction, making real estate a popular hedge against inflation. Inflation can also benefit investors earning income from rental properties, as higher house prices often equate to higher rents. However, higher interest rates often cause investors to ask for higher limits, which could have a negative effect on commercial real estate valuations. In addition, commercial real estate can be locked into long-term agreements that cannot be adjusted for inflation or rate changes.

cryptocurrency

Although the track record for digital currencies is not long, it was recently discovered that cryptocurrency does not appear to be as strong an inflation hedge as originally predicted. From mid-April to mid-July, cryptocurrency turned out to be a 95% negative correlation to 10-year US inflation-indexed bonds. Not only is cryptocurrency moving against inflation, but it has also recently failed to maintain asset value, with Bitcoin’s recent spike taking a loss of almost 72%.

farmland

The long-term valuation of agricultural land is driven by two major trends: a growing demand for food and land scarcity. Quality agricultural land is becoming increasingly scarce worldwide; the United States lost 1.3 million hectares in 2021 alone. At the same time, the global population is expected to strike eight billion more than nine billion people later this year and by 2050. To meet projected global demand, farmers must: double amount of food in the next 50 years – all while using less land.

In addition to price increases, farmland investors can also benefit from the annual cash yield generated by farming activities. Therefore, when commodity prices rise, the yield of agricultural land should also increase. As a result, farmland has traditionally been well located to protect asset value and generate income, especially during times of inflation. In a 50-year study of farmland yields (1970 to 2019), the annual yield of farmland was more than 2.5 times higher than the average annual yield. CPI rate.

Related: Inflation is another beast for entrepreneurs. Here’s how to protect yourself.

Despite falling prices in August 2022, many predict inflation to hover around 8% for the rest of the year. While inflation fears remain high, both domestically and abroad, there are also plenty of opportunities for investors – through both traditional and alternative options.