Blog: Hedging Inflation
By Jeff Pollock
Inflation is on everyone’s radar – consumers, investors, and most of all, the central banks.
South of the border, inflation is running at +7.0% -- its highest level since 1982. The major contributor to this spike in prices is a global shortage in semiconductors, which caused the price of used cars to skyrocket +37% last year.
Here at home, inflation is +4.8%, a level unseen since 1991. Unlike in the US, Statistics Canada does not include the price of used cars in its inflation calculation, which explains the variance. Our prices were driven higher because of food (+5.2%), new passenger vehicles (+7.2%), and homeowners’ home and mortgage insurance (+9.3%). Excluding higher gasoline prices, inflation ran at +4.0% last month compared to the year before. Because Canadian wages only rose +2.6% over the same period, the purchasing power of Canadian consumers has unfortunately declined.
Earlier this week, US Treasury Secretary Janet Yellen said she expects inflation to retreat to +2% by year-end. One of her predecessors, Larry Summers, however, said he doubts this is likely. We side with the latter and believe inflation will remain elevated for some time to come.
While it has been unnecessary to navigate an inflationary environment for the last three decades, the landscape has changed, and our team is employing the following strategies to protect and appreciate the money of our clients.
Buy Real Estate
Researchers at MIT analyzed the correlation between real estate and inflation between 1978 and 2016. Their findings concluded that real estate responds favourably to inflation. As prices rose, the demand for retail properties gained most, followed by apartments, industrial space, and then offices.
Additional research conducted by the Wharton School of Business corroborated this finding. In 1979, US inflation hit +13.5%, its worst year since 1947, yet real estate stocks appreciated +24.4%. Between 1974-1981, the most inflationary eight years in US history when prices rose +9.3% per year, real estate stocks returned +16.3% per year for investors.
According to research from Wells Fargo, which looked at sector returns in months where inflation rose by at least +0.3% (or, +3.6% annualized) over the last two decades, oil stocks posted stronger gains than any other sector – growing +40% during these inflationary months.
As environmental concerns escalate, many investment managers have publicly committed their plans to divest their energy holdings. The two most notable advocates have included The Rockefeller Foundation and Norway’s colossal sovereign wealth fund. However, electric vehicles will take many years to overtake conventional vehicles; airplanes will not be replaced by the metaverse any time soon (if ever); and alternative energy will continue to require government subsidies in order to remain a viable alternative. After years and years of disappointing and lagging performance, energy was the top-performing sector in 2021. Perhaps many investors that previously committed to shun the sector may now have second thoughts.
Buy Royalty Companies
While not a specific sector, royalty companies earn a percentage of revenues from their operators. In other words, royalty companies are not exposed to the rising expenses that their subsidiaries are responsible to cover from a contractual basis.
SPWMI views inflation through the same lens as Larry Summers and believe it will not condense to a mere 2% by year-end. Because of this view, we have employed the strategies discussed above to preserve and enhance our client’s money in today’s inflationary environment.
DISCLAIMER: The opinions expressed in this publication are for general informational purposes only and are not intended to represent specific advice. The views reflected in this publication are subject to change at any time without notice. Every effort has been made to ensure that the material in this publication is accurate at the time of its posting. However, Schneider & Pollock Wealth Management Inc. will not be held liable under any circumstances to you or any other person for loss or damages caused by reliance of information contained in this publication. You should not use this publication to make any financial decisions and should seek professional advice from someone who is legally authorized to provide investment advice to assess your goals and objectives, personal circumstances, and make an informed suitability assessment.