Combating Inflation with Diversification
Doug Walters
Inflation concerns are on the rise and one way to protect your investments is to know the difference between being diversified and well-diversified.
For years, the primary concern about inflation in the U.S. was that there was not enough. Now, largely thanks to the pandemic, we are suddenly flush with price increases and the Fed has officially turned its focus from improving employment to inflation containment. How should investors be positioned to face this rising concern?
Let’s start this discussion first by saying that high, sustained inflation is not inevitable or perhaps even likely. Absent a pandemic, rapid technological developments have become a deflationary force. Think about the $4000 you could have spent on a 46″ 1080p “flat screen” TV back in 2005 compared to the $300 for a 50″ 4K Ultra HD TV today. Those dynamics are not going away. In addition, beginning this week, The Fed has squarely placed its attention on limiting inflation. The reality is that investors still do not know if this current bout of inflation will be transient and that is okay.
Such is the nature of investing. We are never in a position where we have definitive information about the future. Therefore, the goal should not be to load up on risky assets, like commodities, that tend to outperform during inflationary periods, but rather ensure that you have a portfolio that is ready for the future, in whatever form it takes. We call that a “well-diversified” portfolio. It is easy to be diversified but more challenging to be well-diversified.
To do so requires looking deeper than just “stocks and bonds.” What stocks? Do you have broad factor exposure (like Quality, Value, Momentum, and Size), or are you focused too heavily on mega-cap growth? Do you have international exposure, including emerging markets? Do you have enough small-cap exposure? Equities provide some inflation protection but have you considered Gold and Treasury Inflation-Protected Securities (TIPS)? Have you appropriately avoided risky, illiquid asset classes like alternatives and cryptocurrencies? A well-diversified portfolio correctly addresses all of these questions.
Headlines This Week
Stocks fell nearly 2% this week. A plethora of economic data was released, but only two things really mattered to investors this week: The Fed and Omicron.
Wild Wednesday
The conclusion of the Fed’s FOMC meeting on Wednesday was bound to make waves and investors were not disappointed. Stocks rallied as the Fed Chairman spoke, sending the S&P 500 up to near all-time highs. So what did the Fed say? They:
- will double the pace of asset purchase tapering from $15B a month to $30B,
- removed “transitory” as an adjective to describe inflation,
- showed a median forecast for three rate hikes in 2022,
- do not see a long delay between tapering and rate hikes.
Inflation has been an overhang on sentiment recently. This week (or at least on Wednesday), investors were comforted that the FOMC is setting its sights on controlling inflation, even if it means getting more hawkish (which is generally a headwind for portfolios).
Variant Velocity
Also impacting sentiment this week were headlines surrounding the Omicron Covid variant.
- The relatively new strain of Covid is spreading fast and appears much more transmissible than Delta.
- However, early indications continue to be that the symptoms are less severe.
- Concerns are rising of a fresh wave of closures and restrictions, which could prolong the economic recovery.
- Time will tell what is required to stave off this latest Covid challenge.
The Week Ahead
Last-Minute Gifts
Christmas will be coming early for those that wait for monthly U.S. economic data as next week will have quite a few things to unwrap.
- The closely watched consumer confidence index and existing home sales will be out on Wednesday.
- The highlight will be on Thursday as the personal consumption expenditure (PCE) price index is out, along with a finalized estimate for Q3 GDP growth.
- The core PCE price index, the Fed’s preferred inflation metric, is forecast to rise once again to 4.5% year-over-year, up from 4.1%.
- Now that the Fed has announced they will begin accelerating their pace of tapering, the central bank will certainly be checking to see if an even faster pace is needed to keep inflation in check.
- Wrapping the week up will be a very busy Thursday as durable goods orders, personal income, personal spending, and the Michigan consumer sentiment index are all out.
Christmas Surprise?
The People’s Bank of China (PBOC) is set to decide whether to slash interest rates next Monday.
- Amidst concerns over stagnating growth, China’s central bank is faced with the decision to cut rates further in an attempt to stimulate the economy.
- Chinese interest rates have been unchanged since the beginning of the pandemic in April 2020.
- The 1-Year Loan Prime rate currently sits at 3.85%, and the 5-Year Loan Prime Rate at 4.65%.
Happy Holidays
From our Strategic family to yours, we wish everyone a very happy and safe holidays!
About Strategic
Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets of over $1.8 billion.
OverviewDisclosures
Strategic Financial Services, Inc. is a SEC-registered investment advisor. The term “registered” does not imply a certain level of skill or training. “Registered” means the company has filed the necessary documentation to maintain registration as an investment advisor with the Securities and Exchange Commission.
The information contained on this site is for informational purposes and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. Every client situation is different. Strategic manages customized portfolios that seek to properly reflect the particular risk and return objectives of each individual client. The discussion of any investments is for illustrative purposes only and there is no assurance that the adviser will make any investments with the same or similar characteristics as any investments presented. The investments identified and described do not represent all of the investments purchased or sold for client accounts. Any representative investments discussed were selected based on a number of factors including recent company news or earnings release. The reader should not assume that an investment identified was or will be profitable. All investments contain risk and may lose value. There is no assurance that any investments identified will remain in client accounts at the time you receive this document.
Some of the material presented is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. Strategic Financial Services believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.
No content on this website is intended to provide tax or legal advice. You are advised to seek advice on these matters from separately retained professionals.
All index returns, unless otherwise noted, are presented as price returns and have been obtained from Bloomberg. Indices are unmanaged and cannot be purchased directly by investors.