So the Fed finally acknowledged that the inflation is higher and more persistent than what they were trying to convince us all this time. Perhaps this 6.88% reading in December, the highest in 40 years, had something to do with it? With the Producer Price Index reading at 9.6% it is pretty clear that we have a lot of upside inflationary pressures in the system – it was obvious to me that this was the case for months. Hence the Fed statement of aggressively dialing back bond buying and rate hikes next year.
The “transitory” blunder has a more serious side effect – shaking the confidence in the Fed’s abilities to fulfill its mission – price stability and full employment. The impression is also that they got surprised by the inflation pressure and now find themselves contemplating stronger measures to tame it. There is only one small problem with this – such moves caused recessions in the past. I don’t think that the economy will feel any real effect of Fed action until well into 2022.
What are we going to do about this? How do investors protect their portfolios? Higher inflation is especially hitting hard the retirees and other bond investors – pushing some into more aggressive positions that involve higher equity allocations and thus higher risk.
Commodities (especially Gold) and Real Estate have been used in the past as hedges against inflation. Luckily such positions can be easily put on today using ETFs. I am going to reiterate that passive investment in commodities is not an answer – the volatility is high and some have natural production cycles.
Both Gold and Real Estate have a small but positive correlation to the S&P 500 index, which means they can be used to diversify a portfolio, but both also have higher volatility than the S&P 500 itself. I personally prefer managed futures for this role – they have a negative correlation to the S&P 500 and a smaller but still negative correlation to the Bloomberg Barclays Aggregate, with about half of the volatility of the equities. When paired with hedged exposure to the equities, we get a robust allocation that will take advantage of the further upsides, yet provide cushion in the case of the downturn.
Which particular solution is right for you, depends on your circumstances – please discuss with your personal advisor before taking any action.
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