How to invest during inflation

Inflation news has been bad for months, but recently it got worse. On Wednesday, the government reported that the Consumer Price Index rose at an annual rate of 9.1 percent in June, the fastest pace since November 1981.

That horrendous news adds to considerable pressure on the Federal Reserve to rein in inflation. The Federal Reserve is trying, raising short-term interest rates and selling the securities on its $8.9 trillion balance sheet.

But those are blunt instruments. While they can reduce inflation, they do so by slowing down the economy. That increases the chances that the United States will experience a recession, a word often conflated with “fear” in headlines and in analyzes of the economy.

Some of those fears are clearly justified. Add the current surge in coronavirus, Russia’s war in the Ukraine, and the still elevated level of global energy prices to these problems, and you have, at the very least, a recipe for economic trouble.

Certainly millions of people will experience pain, if the downturn is severe enough to be classified as a recession: job losses and dashed dreams always accompany widespread recessions.

If you’re lucky enough to have the financial resources to invest in stocks or bonds, the next few months may be tough, but you can get through them with a little planning.

Readers have been asking for advice and I’ll try to help. However, don’t flatter yourself. I don’t know where the markets or the economy are headed in the short term. Neither does anyone else. As uncomfortable as it is, we must proceed without that knowledge.

The future is never entirely clear, but at the moment it is a matter of pure conjecture.

Long-term investors may be better off ignoring the news: if ever there was a time to do so, this is it, because even a close study of incoming economic and financial data provides no useful guide.

As Paul Krugman said in a newsletter this week: “The different pieces of information that we have don’t seem to line up.” He added: “Some data suggests a weakening economy, perhaps even on the verge of recession. Some suggest an economy that remains strong. Some data suggests very tight labor markets; others, not so much.”

Stock, bond and commodity markets are also opaque. While stocks and bonds have taken a beating this year, commodities like oil, wheat and copper have risen in value; however, the exceptions to that statement are obvious.

Stocks haven’t fallen much lately, bond prices have risen recently (as yields, which move in the opposite direction, have fallen), and the price of oil has moved away from its recent highs.

What is the trend for the next six months? There are many answers but, deep down, nobody knows.

The Fed is in a difficult position.

“The Federal Reserve System has been given a dual mandate,” says the Federal Reserve Bank of St. Louis, “to pursue the economic goals of maximum employment and price stability.” These goals are now in conflict.

Price stability has become the Fed’s biggest problem. The recent inflation report makes additional interest rate hikes almost inevitable.

At the same time, the US unemployment rate was 3.6 percent in June, not far from its lowest level in decades. But the country has not achieved “maximum employment”. Many people have chosen not to work, or been unable to work, due to issues such as a lack of child care or concerns about exposure to the coronavirus. With rapid economic growth, many more people could be expected to join the workforce. But that is not likely to happen now.

The Fed has started to tighten financial conditions to reduce the growing demand for goods and services that helped spur inflation, which is another way of saying that it is deliberately slowing down the economy.

The Fed funds rate, which it directly controls, has already risen from near zero to its current range of 1.5 to 1.75 percent, with financial markets predicting it will rise further to 3.57 percent by March.

At that point, the Fed may need to start court rates, at least the markets think so. But why? One possibility is that inflation is then seen to be moderating, so the Fed can refocus on ensuring maximum employment.

However, it is also quite possible that the Fed will not be able to rein in inflation without triggering a recession. It is also conceivable that inflation will go down largely on its own, as supply chain problems caused by coronavirus and war subside, making further interest rate hikes unnecessarily punitive. for the workers. Oil prices have fallen lately, for example, and gasoline prices have followed suit, although they remain high.

I have been saying since April that inflation may be close to its peak, and this premature statement may now be true.

But don’t count on it.

What is clear is that the Fed has no real choice: inflation is such a hot political issue that the Fed must be seen to be acting to control it, even though its actions certainly increase the risk of a recession.

Markets are supposed to be looking to the future, and a bear market in stocks is underway, down at least 20 percent from the market’s peak.

But I have examined the timeline of the S&P 500 bear and bull markets, along with recessions since 1929, as defined by the National Bureau of Economic Research.

The words of the great economist Paul Samuelson, written in Newsweek in 1966, remain, for the most part, true: “Wall Street indices predicted nine of the last five recessions.” By my generous count, the S&P 500 has forecast seven of the last 16 recessions. That would be an excellent baseball batting average: .440, or 44 percent, but by itself it’s as useless as a crystal ball.

The S&P 500 serves as one of 10 factors used by the Conference Board, an independent business think tank, in formulating its Leading Economic Index. The index has been forecasting “slow growth” but, so far, not a recession. Two other indices, covering current and lagging indicators, are showing strong growth.

What this boils down to, once again, is that we are in the dark.

The implications of these elevated but uncertain risks are simple.

Making sure you can pay your bills and have enough cash for emergencies is crucial. Keep your cash in a safe place and preferably one that will give you a small return. Reasonable options include high-yield bank accounts, money market funds, Treasury bills, and I bonds.

After that, if you’re just starting out as an investor and have decades ahead of you, go long. Put your money in low-cost, diversified index funds, including workplace target date funds, which track the entire stock market. Add diversified bond index funds as you age.

For people with shorter horizons, the situation is more complicated. You may have to make some concessions.

If the economy were to fall into a long and deep recession, the stock market could sink further and not recover for some time. Preparing for that eventuality may mean reducing your stock allocation, even now, after the market has fallen, if you need to use the money soon.

Although bonds have been underperforming lately and lag behind stocks over the long term, high-quality bonds are generally safer than stocks. That is why they are appropriate to reduce risk.

I started my career in the 1970s and grudgingly accept that I am closer to the end than the beginning. About 40 percent of my portfolio is in bonds, more than I had 20 years ago and less than I expect in the future. After decades in stocks, gradually switching to bonds and locking in some of those gains is a comfort.

Find the combination of diversified stock and bond funds that works for you, depending on where you are in life. The economic news can be dire, but with a little luck and a lot of planning, you can weather it.

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