Warning: Inflation May Cause Investors To Freeze
In a world of inflation, investors sitting on cash need to step into the ring and fight. And simple math shows why stocks can be a basic fighting tool.
Inflation is at its highest level in decades. The latest print from the Consumer Price Index or CPI, a measure of average prices compared to the year prior, measured at 7.5% on February 10.
The Conversations About Inflation Index, or CAI (not a real thing), is also at its highest level in decades (not a real statistic). For many, inflation has become a household topic as the effects can be felt in very real terms. Housing in particular has seen a supply shortage that has driven up prices. And the CPI may actually be underestimating the increase in housing prices, as it measures rent equivalents, not home prices.
Consumers feeling inflation beyond the headlines
Changes shown below are over 12-month period ending 12/31/21
(Overall average change of total CPI over same period was +7.0%)
Some may have started to adjust their spending behaviors when it comes to going on vacations or buying cars. But most people will forget that the most impactful thing they could be doing, is putting their investments to work.
Fight or freeze
Fear of inflation can drive investors to do the absolute worst thing for their portfolios – hold on to their cash. We’ve seen this play out in record numbers recently, with record amounts on money market funds – strategies considered “cash equivalents.”
Money market fund assets
15 years (2/1/96 – 12/31/21)
It’s a simple math problem, really. If inflation is higher than your potential rate of return on cash (or strategies considered “cash equivalents,” like money market funds), then you potentially face a negative return.
In the example below, inflation in December 2019 was higher than the 10-year U.S. Treasury, which means you would have had a negative yield. It’s a rather unnecessary depiction that shows 1.5 - 7 = -5.5.
Negative real yields
Inflation vs. the 10-year UST
When faced with this reality, investors can either hold onto their cash and freeze … or fight.
The basics of fighting
Back to our simple math problem. Historically speaking, stocks have been good inflation fighters, as they have tended to outpace inflation. (For one, the S&P 500 Index has returned on average more than 10% each year, historically). So for most long-term investors that are putting their cash to work, there’s no need to panic.
And there are ways to both stay invested in stocks, as well as tilt toward strategies that may be designed to perform well in an inflationary environment – that includes themes like value and dividend growers, or sectors like energy and financials.
But don’t forget – inflation isn’t the only factor driving markets right now. The BlackRock Investment Institute is overweight on equities, as the economy continues to see steady growth and healthy earnings, even amid potential rising rates. Tony DeSpirito, BlackRock’s Chief Investment Officer of U.S. Fundamental Active Equity, wrote most recently that the current market regime requires balance. And as individual companies will navigate higher rates and inflation differently, selectivity withing stocks may be more critical than ever.
Bottom line
When confronted with two choices – to freeze or fight – it may feel uncomfortable for some investors to open themselves up to getting punched. After all, stocks can be volatile. But what most people don’t realize is that they’re already in the boxing ring. Freezing is the worse option.
For long-term investors, put your cash to work. Stay the course with equities. And consider an actively managed strategy within stocks to navigate a potentially volatile and inflationary environment.