Inflation? How To Deal with It?
Inflation is an asset value and money thief that finds your money wherever you hide it.
If we look at the cause, we will be better armed to deal with it. Inflation is not about rising prices, it is about the loss of value. I.e. paying higher prices but without receiving more goods, services, or widgets in return.
What Causes It?
It starts when a reward received is not matched with the production - of anything. If your cup of coffee now costs $5, which was $4.50 a year ago, that's inflation. But if the cup is bigger now, there is no inflation. So it is easy to identify the current seed cause in Australia. The pandemic resulted in a lot of government money being paid to people who actually produced nothing. This is not meant to be critical or political, just a statement of fact.
Money printing, i.e. bond buying, by central banks has the same effect. Theoretically, if the amount of money printed was doubled, the prices of everything would double, and inflation would be 100%.
The reality is somewhere between the two. Of course, money doled out for no production is not strictly a true statement because the non-productive people (and companies) who receive it, do all buy more everyday goods that would otherwise not be sold or produced. The net effect is some inflation but also the survival of our standard of living.
What Can You Do About It?
Governments tend to use the blunt instrument of interest rates. In effect, it is punishing the victim by crushing demand. This is the way of politicians because they can pass the buck to the 'independent' central bank. It doesn't help individuals to protect their assets.
How Do Investors Take Advantage of That and Protect Themselves?
There will always be listed companies that have shrewd managers who will cut costs and try to make their companies more efficient, at the first sign of inflation rising. So it really comes down to identifying company managers who have the ability and perception to take active steps sooner rather than later.
The Q3 inflation rate of 2022 in Australia is 7.3% and rising rapidly. [1] To learn what might happen and what needs to be done, it's better to look at past bouts of high inflation.
The peak was 17.7% in March 1975. [2]
There is almost a whole generation of Australian people who have no experience at all of the inflation and the high interest rates that usually accompany it. And to make the effect worse, many of the highly educated young advisers have limited real-world experience as well. The theory is fine, but it needs to look at past high inflation history to find some answers. Some investors may be able to identify where the protection is, and how to access it by looking at its effect on different asset classes.
The very worst place is pure cash. It simply depreciates at the inflation rate. What needs to be known is an asset that increases in value at or better than the inflation rate. In investing, the easiest thing to do is often the worst thing to do. People who talk about cash as king often have lots of it. It's like taking advice on inflation hedges from people who are unaffected by it.
Many investors have personal preferences in asset classes. Property and stock investing both have a history of always recovering well. The stock market may tend to have an overall more stable long-term uptrend, and it may have the advantage of available instant liquidity. So maybe an ETF index fund can take care of inflation. For active investors, an even better inflation hedge effect can be achieved. There are many ways of assessing inflation hedge stocks to suit your personality.
The All Ords index was around 400 in 1975, it is now 6600. That's a compound rate increase of 6% pa, continuously for 48 years. While inflation is highly variable, - from near zero to near 8% in the last five years, - historically it averages much less than 6%. [3] Aussie shares: 50 years and we're finally ahead (firstlinks.com.au)
Over the very long term property will usually protect assets very well, but not so much in the short term. Property values are impacted by rising interest rates from two perspectives. Firstly, higher rates limit borrowers' purchasing power, which reduces demand and takes buyers out of the market. Secondly, inflation-induced increases in maintenance costs can prompt a re-evaluation and adjustment of property values. Good property may not decrease much in value, but it becomes much harder to sell, which reduces its practical ability as a hedge against inflation.
Bond trading and investment can also be a rewarding hedge, but that requires expertise in the narrow field of interest rate prediction. Which is sometimes subject to political interference. Wild left-field events like the Ukraine war can bring bond strategies undone literally overnight. Such events will affect all markets.
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[1] https://tradingeconomics.com/australia/inflation-cpi
[2] https://www.abs.gov.au/statistics/research/70-years-inflation-australia
[3] www.abs.gov.au/statistics/research/70-years-inflation-australia
