How to Protect Yourself Against Inflation

By Keith Kaplan

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If you’ve been to the grocery store lately, you already know that you’re getting less food for more money. Not only are prices going up, but companies have been scaling back the amount of food in their packaging.

Consumer advocate Edgar Dworsky has tracked the downsizing of products over the last 25 years. He found that dozens of product packages have declined in weight or size this year, but the prices largely remain the same.

Cereal, toilet paper, canned cat food, and other goods have experienced a phenomenon known as “shrinkflation.”

We anticipate that more companies will exercise this practice in the months ahead.

Inflation remains a hot-button issue. The Federal Reserve has largely kept its head in the sand in 2021. This past March, the Fed said that inflation would be “transitory.”

Now, the Federal Open Market Committee (FOMC) members are warning that it will persist well into 2022, with other economists suggesting that problems will continue through 2023.

If you’re an investor in bonds, you might worry that your coupon payments will fail to keep up with inflation. And even if you own Treasury Inflation-Protected Securities (TIPS) to protect against inflation, good luck getting the government to agree with the “real” inflation numbers compared to the Consumer Price Index.

Today, I want to talk about three different investments that will help protect you against inflation over the next 12 months.

Inflation Protector Sector No. 1: Oil and Natural Gas

The price of West Texas Intermediate crude recently surpassed $80 per barrel. JPMorgan Chase suggests that crude prices could surge to $200 per barrel in the years ahead due to a brewing supply-demand imbalance.

The price of crude and its byproducts like gasoline is a primary driver of inflation across an economy. In the U.S., nearly everything delivered to retail stores is done so by truck. And with diesel fuel prices up significantly this year, consumers are feeling the pinch.

Energy producers and master limited partnerships (the upstream and midstream of the industry, respectively) provide direct protection in the face of rising crude and natural gas prices. Companies like Chevron (CVX) and Northern Oil & Gas (NOG) will see shares appreciate when their oil and gas fields increase in value on their balance sheets.

Meanwhile, master limited partnerships like Enterprise Products Partners (EPD) and Energy Transfer (ET) can benefit from an uptick in shipments in energy commodities. This is because the companies own pipelines and storage space that experience high demand when producers pull more energy commodities out of the ground and send them downstream to the refineries and manufacturers that process them.

Inflation Protector Sector No. 2: Financial Institutions

The Federal Reserve has a dual mandate. First, it aims to promote full employment in the economy. Second, it must manage inflation. For the last decade, the Fed has largely fallen short of its target inflation rate of 2%, despite what you might have seen at the retail level.

Now the economy is running hot, as is inflation. The Fed’s key mechanism to control inflation is an increase in interest rates. Although the Fed will likely not raise benchmark interest rates until late 2022, the market itself has pushed the 10-year Treasury bond higher. The market could continue to press interest rates higher in the months ahead should inflation continue to rise.

The biggest beneficiary of rising interest rates is the banking sector. Investors can eye large financial institutions like JPMorgan Chase (JPM), but they could also benefit from regional and community banks.

StoneCastle Financial Corp. (BANX) is a closed-end fund that manages a portfolio of community banks and other assets typically held by these institutions. Although it has a market capitalization of just $147 million, it pays a 6.8% dividend and would greatly benefit from an uptick in interest rates in the year ahead.

Inflation Protector Sector No. 3: Emerging Market Stocks

If the value of your currency is falling, consider diversifying outside of the United States. Investors have a variety of ways to play global markets. For example, they might look to global companies with extensive reach in other economies. Traditionally, investors may want to look at companies with growing market share in countries like Brazil, Russia, India, China, and South Africa (collectively known as the BRICS).

For example, Vale S.A. (VALE) is a Brazil-based producer of iron ore, nickel, copper, and other metals used in construction worldwide. In periods of inflation, these metals typically increase in price and benefit from their commercial demand.

Or investors might want to take a broader approach with the Vanguard FTSE Emerging Markets ETF (VWO). The ETF has exposure to Vale, Chinese social media giant Tencent Holdings, Taiwan Semiconductor Manufacturing, and Reliance Industries.

Conclusion

Inflation is likely here to stay, but it’s not too late to position your portfolio accordingly. Looking ahead, the Federal Reserve will likely start tapering its bond purchases in December before setting a plan to raise benchmark interest rates next year. Companies that offer inflation protection, like banks, energy companies, and mining giants, tend to provide strong dividends.

I will be back on Friday to discuss AT&T and Verizon, two other companies that pay strong dividends but appear to have vastly different approaches to the 5G space.