Investors looking for safe havens during the worst inflation in more than 40 years are out of luck.
As markets sink on fears that the economy is headed for, or possibly already in, recession, individual investors are looking to higher fundamentals to protect their assets.
Several traditional inflation hedges have worked well in the past: gold, real estate investment trusts (REITs), oil, and Treasury Inflation-Protected Securities (TIPS). More recently, crypto has also been viewed as a potential hedge.
This time, however, investors are hitting a snag. Since June 1st, all popular inflation hedges have lost money. Benchmark Crude Oil, Gold, Silver, indices tracking REITs and TIPS, and Bitcoin are all down.
In other words, traditional inflation hedges do not hedge against inflation.
The cause is a confluence of problems: Inflation is high around the world, and the pandemic and geopolitical chaos unleashed by Russia’s invasion of Ukraine have upended bets that usually paid off.
When inflation hits, investors have invested their money in things that are getting more expensive. This was usually a winning strategy.
A 2021 analysis by researchers at hedge fund Man Group Plc and Duke University examined a century of data from the US, UK and Japan and found that both stocks and bonds fall during periods of inflation. US equities have returned -7% in eight periods of high inflation since World War II. Commodities – often a source of inflation – tend to do well. Gold, oil and other physical assets ended all periods of inflation in the green, analysts noted.
Inflation, by definition, is a decrease in the purchasing power of the dollar or other currencies. But today is different: The strength of the US dollar is growing on a global scale, although they buy less domestically. Job growth and other economic data remain relatively strong, leading investors to believe the Fed will continue to hike interest rates sharply. This strengthens the dollar, which in turn hurts the value of gold.
REITs and cryptos have not been safe from geopolitical turmoil and rising interest rates either, scare away investors. Oil has recently fallen from record highs as the Biden administration works to tap emergency reserves and increase supply.
TIPS were created to protect against inflation by adjusting yields based on changes in the consumer price index – investors get more when inflation rises. But inflation is now at its highest since the 1980s and TIPS yields are falling. That’s because prices are more responsive to what is expected happen with inflation in the coming years. Inflation reflects future expected prices, and rightThe Fed’s rate hikes have affected these expectations.
“Trying to hedge against inflation is really difficult,” said Tom Graff, head of investment at Facet Wealth. “Markets will always price in what they think is going to happen over a longer period of time, and they’re not stupid: Inflation is rising right now, but it probably won’t stay that way forever.”
As long as the Fed is credible and says it will work to cut prices, inflation will not be fully priced into the hedge, he said.
However, the most reliable protection against inflation: equities. As long as you have patience Stocks have historically outperformed inflation, but for a longer period of time.
“Over the long term, stocks tend to outperform inflation by a wide margin. But it’s really more like a marathon runner beating a sprinter in the long run,” said Shawn Cruz, head trading strategist at TD Ameritrade. In the meantime, many investors are trying to rebalance their portfolios.
“I think the world gets the joke: the Fed is going to stamp out inflation one way or another,” he said. “Inflation trading is over.” Instead of trying to hedge against rising prices, Graff added, individual investors would be far better off running the marathon and weathering the current market volatility.
The bad news is that investors will have a hard time making money in this inflationary environment — even if they’re hedged against it. The good news is that financial markets don’t seem to believe that inflation is really embedded in the US economy.