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What is the ‘inflation trade,’ and how can you play it in your portfolio?

June 28, 2021, 9:00 AM UTC

Inflation has a consequential impact on everything from the price of food to mortgage rates—and, of course, returns on money you’ve invested.

Following a period of months when the economy was reopening, demand picked way up, but supply chains remained disrupted. Consumers have suddenly found themselves paying far more for common goods than they were a year ago. According to the Bureau of Labor Statistics, prices for nearly everything—from food to shelter to transportation—are up. The price of used cars and trucks rose more than 7% in the month of May alone, according to the bureau.

When your dollars don’t buy what they used to, that leads to a spike in inflation. The core personal consumption expenditures price index rose 3.4% in May, marking its fastest increase since the early 1990s. While the Fed tends to cut rates to spur economic activity during downturns, now that things are looking up and prices are rising, the central bank says it’s speeding up its timeline to eventually raise rates and curb inflation. But in the meantime, inflationary periods present a quandary for investors. While it’s not a negative for all asset classes, such periods do affect where and how investors can make money.

In particular, high inflation can jolt investors who have a substantial concentration of bonds, or who are near or in retirement and can’t afford to take on additional risk. “The thing with inflation is that it’s not always bad—it’s just better for certain areas of the market than others,” says Brice Carter, chief investment officer of Financial Strategies Group, a $380 million independent financial advisory firm in Michigan.

The Fed’s statements didn’t come as a surprise to asset managers, who have been forecasting higher inflation rates for months. Factors like a fiscal boost and escalated production costs made that seem imminent. The consumer price index, which measures the change in what individuals are paying for goods and services—saw in April its sharpest rise since September 2008. 

There are strategies—sometimes referred to as “inflation trades”—investors can use in an attempt to maintain returns in their portfolios, all while hedging risk. Here are some of the methods Carter and asset managers like BlackRock have recommended to investors during inflationary periods. 

Use TIPS

Treasury inflation-protected securities—also known as TIPS—are government-issued securities designed to adjust with the price of inflation and protect the value of money at the time it was invested. TIPS are low-risk investments, and—because they are inflation-protected—can be a useful alternative to lower-yielding fixed-income investments.

Carter’s financial advisory firm started cutting back on traditional fixed income in favor of TIPS in May 2020, when rates on Treasuries “were just worthless,” he says.

“All you needed was pretty mild inflation for it to make more sense to own TIPS over Treasuries,” he says.

Value stocks

Value stocks are companies perceived to be trading below their underlying fundamental value, while growth stocks are expected to outperform market gains based on their future value. 

Value stocks tend to outperform growth stocks during inflationary periods, according to BlackRock data going back to 1927.

“It is only when inflation is very low that value performance pales—as evidenced in the past 10 years,” Tony DeSpirito, chief investment officer of U.S. fundamental active equity at BlackRock, wrote in a market analysis note in March.

Because of this, value stocks could be a useful way to gain exposure to better returns.

ETFs such as the SPDR S&P 600 Small Cap Value ETF (SLYV) or the Vanguard Value ETF (VTV) seek exposure to value stocks like Macy’s, Johnson & Johnson, or Bank of America.

Gold

Gold has long been seen as a method of storing value, as it can pull through periods of volatility or a rough economy.

Carter decided to invest clients into gold based on its historical performance during four periods of low—but rising—inflation since 1998. Gold experienced an average annualized return of about 16% during those periods, he says.

However, gold’s price can fluctuate, as 2020 highlighted. 

Then there’s the looming question: How long will this inflationary period last? Carter for one questions whether everything will truly return to normal, though he expects price surges to work themselves out in 12 to 18 months. “Once you start raising wages…It’s going to build on itself,” he says.

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