Hedging Inflation

We all were taught that a penny saved was a penny earned, right? Not today, thanks to inflation.

This morning we learned that in November, the consumer price index (CPI) climbed 0.8% and is up 6.8% from last November. Yes, headline inflation is now the highest since 1982. This comes as no surprise to anyone who has shopped at the grocery store and/or gassed up their vehicle recently. Inflation is back and it is biting into the budgets of every American household.

We get asked all the time: “Is there a way to hedge our portfolio against inflation?” Our simple answer is “Yes, continue to own high quality equities for the long term.”

Forget for a moment the difficult question of how durable this recent inflation spike will prove to be. Worry about rising inflation has been well founded thus far, but there is still no consensus on whether it will be transitory or long-lasting. Even though we have not seen inflation like this in decades, interest rate movements have been relatively subdued. In fact, the ten-year treasury yield reached a recent high of 1.67 in mid-October, and has since fallen to around 1.47. Even gold, which is widely believed to be an efficient short term inflation hedge (despite evidence to the contrary), is no higher than it was a year ago. In our opinion, if we were headed into a prolonged period of 1970s style stagflation (slower growth combined with rising inflation), both these indicators should have long since begun sending up flares. Also, if stagflation was imminent, we would probably start to see the value of the dollar drop. That is not the case, as the dollar is near a 16-month high.

Let’s also forget the fact that all the major US stock indexes have significantly outpaced inflation this year. If your cost of living is up 6 percent, and your equity investments are up two, three, or even four times that much, you would have so far successfully hedged against inflation this year. But again, let’s not use this cherry-picked example, because such short-term comparisons are for headline writers, not serious investors.

We need to go back in time a bit to search for a meaningful comparison. Let’s go back to the year 1990. Be assured that every single headline about inflation you’ve seen this year would mirror everything you would have been reading in 1990. So, what happened in 1990? We were in a recession with the Gulf War on the horizon. The S&P 500 index ended the year at 330. At the current level of 4680, this index is up about 14 times. In 1990, the cash dividend of the S&P 500 was $12.09. This year, that same cash dividend is $61.03. Equity income has thus quintupled. The Consumer Price Index (CPI) in 1990 stood at 133. Per the most recent November report, CPI now stands at 278. Thus, the cost of living has just barely more than doubled.

In summary, if we look all the way back to 1990…

• Mainstream US equities (the S&P 500) have risen in value about 14x
• Cash income from mainstream equities has increased about 5x
• Cost of living is up merely 2.1x

Thus, our answer to the question: “How should we hedge our portfolio from rising inflation?”

Own high-quality equities for the long term.