I feel like I’m talking about inflation as much this year as I did about real estate problems two years ago and the recession looming last year. My advice to move out of real estate in 2006 turned out to be spot-on, as did last year’s recession warnings. I expect that my inflation advice right now will prove to be equally valuable. So, I apologize for repeating the subject, but inflation is becoming a bigger issue all the time and the time to prepare for it is before it gets here, not after.
Inflation lowers the purchasing power of your money. In my Yavapai College class, Basic Investing for Retirees, we discuss why keeping up with purchasing power is a much better goal than merely counting the numbers of dollars you own. If your dollars buy less today than they would last year that is a problem no matter how many dollars you have.
In addition to rising prices of commodities (food, oil, etc), we now have inflation coming in from Asia. For many years our prices were held down by the availability of low cost goods from Asia, especially China. However, China has just posted a 7.1% inflation rate for the last year. What this means to you is that goods from China will be about 7% more expensive than a year ago. This also means your purchasing power just went down 7% if you buy things made in China.
China is now a major exporter of inflation.
CD rates have already fallen below the rate of inflation, making them sure losers in terms of purchasing power. A big risk of any fixed rate investment – CDs bonds and many annuities – is that inflation can destroy the purchasing power of your principal faster than the interest accrues. You steadily fall behind in terms of purchasing power.
The chart above shows inflation since in1913 when the Fed first started tracking it. The 3 large peaks of inflation began their rises during WWI, WWII and VietNam. So the first observation one can make from this data is that wars seem to contribute to high inflation. And, we do have a war going on, don’t we?
Another item to be gleaned from the data is that in the past inflation high points have been about 30 years apart. The last peak was in 1980. It seems like we may be due for another spurt of inflation according to this pattern.
And notice that inflation does not normally creep up slowly. Once it gets going it spikes up sharply. This would seem to say that if you wait to read about inflation in the paper, you may be too late to adjust your investments.
How bad might inflation get? The trend line I have drawn on this chart suggest that if inflation spikes up again, we could see it go as high as 10% – and quickly. Now you know why I keep writing about inflation.
The good news is that we have survived all the previous spikes in inflation, and we will survive this one, too. There is no need to buy canned goods and head to the hills. Certain investments handle inflation better than others, and the key for investors is to make prudent adjustments to your investments so they will be less vulnerable to inflation.
We handle this automatically for you in our managed accounts. If you have unmanaged assets you would like to discuss, please call the office for an appointment. The number is 778-4000.
Update on Your Accounts
In the mean time, your managed accounts are doing well.
The adjustments I made to our growth accounts in January served us well, limiting losses in model accounts1 holding stock funds to about ¼ of the stock market indexes2. In February we posted gains in those same accounts.
Due to the continuing uncertainties in the markets, all of our growth accounts hold larger than normal money market balances right now. We also hold investments in Latin America and the Middle East, managing the risk by hedging with an inverse emerging markets fund. Some growth accounts also hold some bond funds which are either inflation-protected bonds or global bonds, both of which are doing well. Agricultural commodities along with a globally balanced fund that are both hedged with inverse S&P 500 and inverse technology funds round out our holdings in our growth strategies.
One of our flagship strategies since its inception in 2001, Tactical High Yield underwent a name change in January to Flexible Income in order to better reflect with the broader universe of investments I am using. Instead of focusing just on high yield bond funds, we are using a wider array of bond funds, currency-deposit funds and some inverse funds, too.
In the past six months we have used the currency funds for the Australia, Canada and the Euro all with good results. We only buy currencies in up trends against the dollar, so we have the opportunity for a gain, plus they pay us interest while we wait. Today’s annualized interest on our current holding, the peso fund, is 5.92%. Not bad.
Of course you don’t want to park your CD money in one of these funds, because they can also go down in value. We manage the risk of these currency funds for you by monitoring the prices closely and as long as they go up or stay steady we will continue to hold them. But if they slip just a little bit we move back to the relative safety of the money market fund.
The new mix of investments is providing more consistent returns than the more narrowly focused approach of years past. Flexible Income had a great year last year. I would like to think it was just my brilliant management, but in reality it may have been just a strong market for our investments. Sometimes it is easy to confuse the two.
Municipal Bonds Now on Sale
Municipal bond funds have taken a curious turn as institutions and hedge funds are forced to sell holdings. Ironically, the only thing they can easily sell is their best holdings – high quality, medium term municipals – the same things our muni funds hold. This is driving the price down on munis at the same time that Treasuries are going up. It is a crazy business sometimes.
The frenzied sale of municipals is not matched by action in the treasury market, so normal hedging, using treasuries, would not help. Ironically, municipals are now paying more interest than Treasuries. I have never seen that in over 30 years of helping clients invest. It may never have happened before. Sudden waves of panic selling like this are almost always temporary, so we are patiently holding our muni funds and collecting the interest, despite their current weakness.
Did you know?
Waiting to collect social security at age 66 rather than age 62 is similar to earning 7% per year on your investment in social security. Wait until age 70 and the effect is similar to earning 8% for those last 4 years. Certainly your expected longevity plays a part in this decision, but if you plan to live a long time, waiting to collect social security may be a smart bet. Even if you have to spend down other lower-earning accounts to do so, the numbers are attractive.
Spring College Class Schedule
Advanced Investment Analysis Using Charts
Three 2-hours classes beginning April 3rd at Yavapai College. (Tuition $45) This course is designed for the somewhat experienced investor who wants to learn to use technical analysis (charts and graphs) for investment decisions. Call the College at 717-7755 to register, or see our web site for details. Course #081864.
Socially Responsible Investing
One 2-hour class on April 23rd at Yavapai College. (Tuition $25) Using social screens for your investments can enable you to affect the world in the areas that are most important to you. By including or excluding certain types of companies or industries from your investments, you can direct your investment dollars to those areas more in harmony with your values in life. Call the College at 717-7755 to register, or see our web site for details. Course #081866.
Basic Investing for Retirees went very well and participants really appreciated the information and interaction. If you are interested in this class, please watch this space for the fall schedule.
1. The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
2. *The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
Information in this newsletter is derived from sources deemed to be reliable, however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented or any opinions expressed herein constitutes a solicitation for the purchase or sale of any security. Adviser will not transact business unless properly registered and licensed in the potential client’s state of residence
Investment Advisory Services offered through Hepburn Capital Management, LLC, a Registered Investment Advisor
Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member NASD/SIPC
Cambridge Investment Research is not affiliated with Hepburn Capital Management, LLC
2069 Willow Creek Road, Prescott, AZ 86301