And what are “inflationary assets” anyway?
We’re using the term “inflationary assets” here to indicate those asset classes that increase during periods of inflation, namely those that have a high correlation with the pace of inflation.
Needless to say, there is a fair amount of research on this topic. After all, don’t investors want to know which kinds of investments will do well in the various segments of the business cycle?
Opposite Viewpoints
For dividend investors, we are in an interesting position. We generally seek to increase our holdings when prices decline. Which means when some assets are out of favor.
So assets that correlate with inflation are not cheap during periods of high inflation. Since these assets become more expensive during high inflation, we tend not to buy them at this time, and we see that dividend reinvestment buys fewer shares when prices increase.
Therefore, it is obvious to reiterate that “[w]e generally seek to increase our holdings when prices decline.”
It does take a little doing to keep track of prices and assess whether they are historically high or low. As mentioned in some previous posts, I do maintain a list of target prices for each of the stocks I own. When the current price approaches (namely, declines towards) the target price, I start to pay attention. Once a price declines to or below my target, I may or may not trigger a buy. I do not automatically buy because I know it is certainly possible that the price could decline further. Or maybe I feel I own enough shares of that security. Or for any other reason.
Why Should We Care?
Since it is the stated goal of the Federal Reserve to maintain some inflation, albeit a target of 2%, it is appropriate to orient one’s portfolio to not only take advantage of that fact, but also to protect one’s financial condition. If all I ever did was to put my dollars under my mattress, I may end up with many dollar bills, but they would be worth less over time. By buying assets that appreciate over time, I have the chance to arrive at a much more satisfactory result.
When inflation is greater than the Federal Reserve’s goal, we still need to protect ourselves. Prices increase and as a result we are in a position to lose purchasing power.
So Which Assets Do Well During High Inflation?
There are many perspectives to this question. It is easier to first address things that do NOT do well in an inflationary environment. Since interest rates rise during periods of inflation, long-term-fixed debt is a poor investment. These tend to lose value as interest rates rise. Think of the relationship between bond interest and bond prices. As interest rises, bond prices decline. Conversely, when interest rate decline, bond prices rise.
So what does well? Things that do well are often energy, certain commodities, some real estate, and some equities. Some commentators include gold, but this has a very mixed record regarding inflation. In addition, gold does not pay dividends.
Companies that sell commodities, as mentioned, tend to have increased profits during inflation, but their costs and results can be very volatile,
Warren Buffett has been quoted as saying “The best businesses during inflation are the businesses that you buy once and then you don’t have to keep making capital investments subsequently; …any business with heavy capital investment tends to be a poor business to be in in inflation and often it’s a poor business to be in generally.”
On the theme of energy, during the last two years, petroleum companies like Exxon, Chevron, BP, etc., all have all seen their stocks surge higher. It is also appropriate to mention that as recently as 2020 petroleum prices crashed to an 18-year low. Volatility exists and is never fully vanquished.
Your favorite search engine can find many more examples of what analysts determine are optimal investments for inflationary times.
For dividend investors, an ideal company is one that has the ability to raise prices during inflationary times. This can be seen as detrimental to a person as a consumer, and beneficial to a person who is a stockholder. (Another argument to becoming a stockholder.) A company that can raise prices during inflationary times can cover its rising costs, and also return some of its income to shareholders. By contrast, a company that is constrained from raising prices faces difficulties as its raw materials more often than not have increased costs.
Quality matters. Not all companies or stocks react the same to inflation. Quality of the company and its financial condition as well as the economy overall determines how a stock will respond to inflation.
Do you own “inflationary assets”? Let me know here.
Moonrise over Mono Lake, photo by the author, 2023. Mono Lake is an inland saltwater lake in eastern California.
The post The Importance of Owning Inflationary Assets appeared first in Smile If You Dare.