The Best Protection From Inflation

Inflation is on people’s minds.  We are not back in the 1970s but the cost of ‘stuff’ is going up quicker than it has done for a long time. The latest inflation reading in the US was 6.8%.

The CPI report breaks that figure down, as follows: (data from Charlie Bilello):

  • Fuel Oil: +59.3%

  • Gasoline: +58.1%

  • Used Cars: +31.4%

  • Gas Utilities: +25.1%

  • Meats/Fish/Poultry/Eggs: +12.8%

  • New Cars: +11.1%

  • Overall CPI: +6.8%

  • Electricity: +6.5%

  • Food at home: +6.4%

  • Food away from home: +5.8%

  • Apparel: +5.0%

  • Transportation: +3.9%

  • Shelter: +3.8%

My guess is that we have seen significantly higher inflation here in Cayman.

There are a couple of consequences of inflation.

There’s the obvious monthly impact that your finances feel if you don’t get a wage increase that keeps up with inflation.  You get squeezed.  The cost of life increases and unless you adjust (which is hard) your savings take a hit.

The other side of the coin is that the savings you do have, if they are in cash in the bank, are worth less as each month and year go by.

Here’s how it works.  Let’s say you have $100,000 in cash in the bank today, earning basically nothing.  At 6.8% inflation rate, that $100,000 will buy a little less than $94,000 worth of stuff next year and less than $88,000 worth of stuff the year after.

You still have 100,000 $1 notes, but your purchasing power has decreased.  You must think about money as purchasing power, not the number of units that you have.

If inflation continues at 6.8% per year (I am not saying it will), the cost-of-living doubles in 10 years.  If the cost-of-living doubles and your cash doesn’t grow, your purchasing power has halved.  It doesn’t really matter how much cash you have, it matters what you can buy with that cash – at that rate, in 10 years you can only buy half as much stuff.

High and sustained inflation isn’t great for anyone but it’s particularly bad news for retirees who might be relying on fixed income sources, and for anyone who has lots of cash in the bank or fixed-income investments, such as bonds.

When inflation is high the touted antidote, more often than not, is gold. 

Here’s the news.

Gold is not a good inflation hedge.  According to Charlie Bilello gold has outpaced inflation in only 45% of rolling 5-year periods.  Even investment grade bonds have done better than that – they have beaten inflation 86% of the time.

There was a 20-year period from January 1981 through to December 2000 when US inflation rose 102% and gold declined 54%.  There is no argument that can turn that around.

Statistically, there is an antidote that works. 

Own stocks for the long-run.

Let’s define “long-run” as the past 62 years, because 62 is the average retirement age in the US.

There are three figures that matter:

1)     What the market has returned over the past 62 years

2)     How much the income (dividends) earned by owning the market has increased over the past 62 years

3)     And how much has the cost of living increased over the same 62 years.

Here are the answers:

1)     At the end of 1960 the S&P 500 stood at 58.  Today it is 4500

2)     The cash dividend paid by the S&P 500 in 1960 was $1.98.  For 2021 it was $60.40.

3)     The Consumer Price Index in 1960 was 30.  At the end of 2021 it was 279.

To put it another way:

1)     The S&P 500 has gone up 77 times

2)     The income received from owning the S&P 500 has gone up 30x

3)     The cost of living has gone up 9x

The healing power of stocks, as protection from inflation, is nothing short of miraculous. No other asset class comes close.

Why is this the case?  Why do stocks protect so well?

The main reason is that companies have pricing power.  That is, successful businesses are able to pass on increases in costs to the consumer (that is you).  They also innovate, they become more efficient, they adapt – businesses are amazing, and when you own a globally diversified portfolio of stocks, you own a piece of all the best businesses in the world.

That’s what you want to own at any point in time, but particularly so when inflation is higher than normal.  Don’t get lured into thinking a piece of shiny metal is the answer. 

Georgina Loxton