Inflation...What to Do?

Inflation has been the top story for a while - even more so now as it approaches 8.5% over the last 12 months. While disconcerting, my guess is that it will take a while longer for inflation to settle down as monetary policy and the supply chain play catch up. A quick recap:

Too Much Money…

After the Fed flooded the market with emergency funds and flatlined interest rates, we knew the easy-money policy would eventually end. We also knew it could be painful, but it probably should have come sooner. Not surprisingly, there's still a lot of money out there, and people are eager to spend it.

…Chasing Too Few Goods

The problem is that the supply chain is, believe it or not, still recovering from the temporary economic coma of 2020 causing continued delays in production across the entire system. Much of this is a result of the efficiency benefits of just-in-time manufacturing, which is probably a topic of conversation in many board rooms today.

With no end in sight, a popular question is, "What should we do with our portfolio in this environment?" This is a good question as it's clearly a unique time to invest. The pandemic even popularized the investing acronym T.I.N.A., which is worth discussing.

T.I.N.A. stands for "There Is No Alternative." Generally speaking, this philosophy supports an equity-heavy portfolio due to a lack of better options. Sidenote: Historically speaking, I'm not sure there has ever been a better option for combating inflation than an equity-heavy portfolio as equity prices are up 100X versus just 10X for inflation over the last 65 years. But I digress.

That said, I agree with the T.I.N.A. philosophy as today's bonds continue to yield less than nothing. As I write this, the 10-year Treasury is sporting a projected negative 5%+ real return. I imagine that only the most fearful investors would willingly sign up to lose 5%+?!

Making matters worse, this doesn't include the price hits that bond investors will likely endure as the Fed raises rates. In other words, it's pretty much the worst-case scenario right now for bond investors. Hence, T.I.N.A.

The obvious next question is whether corporations are in a similarly poor situation? How might they fare in an inflationary environment? The short answer is that we can't know for sure. But there is hope because here's what investors routinely forget: these companies can raise prices to offset their increase in costs.

It surprises many people that even as inflation has worsened, profit margins have actually increased. In fact, according to JP Morgan's Guide to the Markets, profit margins are as high as they have been in decades. Surprising, no? That little fact may help explain why equity market volatility hasn't been worse given the circumstances.

As if equities weren't already the obvious choice given all long-term historical evidence, the choice seems even more apparent today. But this won't stop the doomsayers from saying otherwise.

To be clear, there may be more volatility along the way as the Fed becomes more aggressive in its approach to rate normalization. But to answer the question posed above, we believe that the best strategy in this environment is simply to stand by your plan. It was built for this.