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Inflation is a Monetary Flood

8/21/20

Some investments can swim through an inflation flood, others drown.


The Coronavirus has been a dragging anchor on the global economy. Every country on Earth has seen their GDP’s slow and their unemployment numbers spike. To revive the world from the freefall, governments have added at least $9 trillion in stimulus through direct (printing money) and indirect (loans, guarantees and fiscal operations) methods.

Before the Coronavirus, there was approximately $37 trillion worth of currencies circulating around the globe: this included all the physical money and the money deposited in savings and checking accounts. If you added in CDs, money markets and other time deposits the world total was about $90 trillion. This was the short-term supply of money. When that supply is flooded by about $9 trillion, or a 10% increase, in under 6 months, then a likely outcome is inflation.

Admittedly, this is a fast and loose estimation of the increase in the money supply. Not all the stimulus money should be categorized as short-term; some of the $9 trillion will be divvied out over the coming months and years. And not all is actual cash, like tax holidays and loan forbearance. And some of the stimulus will end up being categorized as long-term investments, which is a $1 quadrillion category. But much of the stimulus will be spent quickly to replace lost wages for workers, and cash flow for businesses. When the world economies recover, much of that $9 trillion will still be flooding the short-term supply. This is a recipe for cost-push inflation.

Not all investments will sink in a monetary flood. Some wear Floaties to stay on the surface. Some are Fixed to the ground and slowly drown. And some Thrive and swim faster.

Floaties—These are assets whose prices can float with the inflation level or can easily pass that price change off to the end consumer.

Most real estate holds its own during inflationary times. And income producing properties, with their dual motors can do better than float, more on that later. Non-commercial real estate owners also usually have the advantage of long-term fixed-rate mortgages, which can become relatively inexpensive in the latter years.

Stock markets, as a whole, tend to float, but some sectors are swimmers, and some are inner-tube loungers. The swimmers include commodity related stocks, like precious metal miners and agriculture companies. Health Care is considered essential, so it holds its own. Consumer staple stocks, including food producers, do well because they sell low-priced necessities. The building material sector is strong because of its close ties to the performance of real estate. And technology stocks can help carry some weight because their products are often seen as must haves for both consumers and businesses.

The loungers can be from many sectors. Banks that rely on issuing mortgages underperform. Manufacturers who cannot raise their prices along with inflation also underperform. And any company that relies heavily on consumers who have a fixed budget, think retirees, will also underperform the markets.

Variable-rate bonds, including government TIPS bonds, are the only ones to keep their heads above water from bond land.

Fixed—Bonds, or any investment that pays a fixed stream of cash flow into the future, are the most sensitive asset class to inflation. With a few exceptions, they are the first to drown.

Preferred stocks usually underperform because they pay a fixed dividend that, like a bond, never increases with the change in inflation. In that same vein, common stocks who are not growing and have a fixed dividend policy, will not keep their heads above water.

Thrivers—As mentioned earlier, income or rental properties tend to thrive because they have two price accelerators. Like the rest of the real estate market, their underlying property values will rise along with inflation, but rental income can also rise as wages and housing costs rise.

REITs can also thrive, for the same reasons as income properties. REITs, as a result of charging higher rents and property price appreciation, can raise their dividends accordingly.

Growth stocks that have no dividend, or a rising dividend, can be swimming thrivers if they are in the inflation friendly sectors mentioned earlier. Like swimming fast downstream, well positioned growth stocks can handily outperform market averages.

Inflation is likely soon, but the severity and timing are dependent on the recovery. If the global economy takes longer to return to growth, or is more anemic than anticipated, inflation will be more subdued. If global growth is stronger than anticipated, than inflation might become more sinister. The point is, when the money supply is increased significantly, planning for inflationary times can be a wise investment.

Justin Hudock

Starboard Wealth Management

Marstons Mills, Massachusetts

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