Here’s How Inflation Might Impact Your Portfolio

Here’s How Inflation Might Impact Your Portfolio

Opinions expressed by Entrepreneur contributors are their own.

The annual inflation rate in the U.S. accelerated to a more than 40-year high of 9.1% in June 2022, experiencing the fastest increase in prices since November 1981. Although the inflation rate fell to 8.3% in August it will likely continue to be under upward pressure for some time.

Yet despite the current environment where stock prices are dropping and inflation numbers skyrocketing, some assets are well-positioned for benefit. For example, farmland tends to do well in inflationary environments. It enjoys jumps in both land values as well as commodity prices. Historically, farmland returns have had a roughly 70% correlation with the CPI. Let’s look at the factors that drive prices up and how they have impacted certain asset classes.

Related: Inflation Is a Risk for Your Business, But Doesn’t Have to Spell Doom

Factors driving inflation

As a result of heavily stimulating the economy during the Covid-19 pandemic, the M2 money supply increased by over 40% from March 2020 to June 2022, while the M1 money supply grew 5x. This influx of money into the economy helped drive prices to a 40-year high; commodities like food now cost 10.4% more than one year ago. Supply constraints continue to be exacerbated by slow port turnaround times, lockdowns, and worker shortages. Consumers are now facing higher prices because of pass-through costs, input scarcity, and other factors. Though they have begun to decline, fertilizer prices, for example, increased 80% in 2021; earlier this year, prices jumped an additional 30%.

The Russia/Ukraine war is compounding inflationary pressure, particularly on global food prices. Russia and Ukraine are major suppliers of commodities, particularly staples like wheat and corn; combined, the two countries export roughly 25% of the world’s grain. Due to sanctions against Russia and transportation challenges within Ukraine, only a fraction of this supply has been accessible to the rest of the world. As a result, wheat prices jumped 37% during the first two months of 2022, while corn prices rose by 21%. While every inflation period is different, historical performance can be used to show how certain asset classes may behave in today’s environment. Let’s take a look at how inflation might impact some of these top asset classes below:

Stocks

In general, real returns of stock prices tend to decline when inflation rises. In fact, from 1979 to 2021, public equity returns have been substantially lower when inflation is over 4.1%. This is due to higher input costs, which causes many companies to have lower profit margins. In addition, stricter monetary policy discourages borrowing due to higher costs.

However, some stock market sectors tend to benefit in times of inflation. Soaring oil and other commodity prices, for example, have led energy sector stocks to generate record profits in 2022; the Energy Select Sector SPDR Fund (XLE) is up 42% this year.

Bonds

Stricter monetary policy in response to inflation has historically negatively impacted fixed-income securities. As we are seeing today, bond prices tend drop when the Fed raises interest rates. As a result, the correlation between stocks and bonds becomes strongest during long periods of high inflation, meaning bonds can also lose their diversification characteristics. This can amplify volatility, particularly for investors that rely on a “60/40” portfolio.

Related: 4 Ways to Protect Your Business From Inflation

Real estate

Historically, inflation and housing prices tend to move in the same direction, making real estate a popular hedge against inflation. Investors who rent out their rental properties can also benefit from inflation, since higher home prices often translate into higher rent. However, higher interest rates often cause investors to demand higher cap rates, which can negatively impact commercial real estate valuations. Commercial real estate could also be locked into long-term agreements that aren’t adjustable for inflation or rate changes.

Cryptocurrency

While the track record for digital currency isn’t long, it was recently found that cryptocurrency does not seem to be as strong of an inflation hedge as was originally predicted. From mid-April to mid-July, cryptocurrency was found to have a 95% negative correlation to 10-year U.S. inflation-indexed bonds. Not only does cryptocurrency move opposite of inflation, but it has also recently failed to preserve asset value, with Bitcoin’s recent peak drawdown reaching a loss of almost 72%.

Farmland

The long-term appreciation of farmland is driven by two major trends: growing food demand and land scarcity. Quality farmland is becoming increasingly scarce worldwide; the United States lost 1.3 million acres in 2021 alone. At the same time, the global population is expected to hit eight billion people later this year while topping more than nine billion by 2050. To meet the expected global demand, farmers will need to double the amount of food over the next 50 years — all while using less land. Farmland investors can also reap the benefits of farmland operations’ annual cash yield. Farmland returns should also increase with rising commodity prices. Farmland has historically been well-positioned to generate income and protect asset value, especially during inflation. In a 50-year study of farmland returns (1970 to 2019), annual farmland returns were more than 2.5 times higher than the average yearly CPI rate.

Related: Inflation Is a Different Beast for Entrepreneurs. Here are some ways to protect yourself.

Despite falling prices in August 2022, many predict inflation will hover around 8% through the rest of the year. While inflationary fears continue to run high, both domestically and overseas, an opportunity also abounds for investors — through both traditional and alternative options.

Read More