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What does the US inflation figure mean for your portfolio?

by , 18 January 2022
What does the US inflation figure mean for your portfolio?
US inflation came in at 7% on Wednesday.

This is so far beyond the US target rate of 2% it's terrifying.

To give you some perspective about how big a miss this is, our SA target rate is up to 6%. So, to miss it as much as the US did, our inflation rate would need to be 21%.

Up until recently, the US Fed argued they didn't have to raise interest rates to combat inflation, since it was “transitory” and would soon disappear. Not only did inflation not come down, but it's actually continued to rise… aggressively.

The last measurement at 7% is the highest rate since 1982.

This has forced the Fed to finally admit it was wrong.

Now you may think this is a good thing. The Fed will get inflation under control, and everything will return to normal, unfortunately history has shown this is rarely the case.

Not only does the US Fed usually see the problem too late, when it does finally react, it tends to overdo the “cure”. This causes a whole new set of problems.
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The knock on effect of inflation could be ‘more inflation’

The reason for this is quite simple, changes to monetary policy take a very long time to impact the economy.

It’s quite likely that we are only just getting the full impact of monetary policy decisions from 12 months ago.

This means if the Fed takes an action, it could be as much as a year to see the full implications.

And if the Fed made the wrong decision, and needed to correct, it could be another year (or more) before we see if the cure even works.

Another issue is workers quickly figure out when inflation is an issue. They notice their pay checks no longer buy as much as they used to.

Last year wages grew by 4.7%. Not bad but still less than the 7% inflation rate.

This means the average worker in the US actually took a 2.3% pay cut.

The next time these workers negotiate their pay, I would expect them to ask for at least 7% more. This will create new inflation in the economy, as businesses are forced to raise prices to compensate for the rise in the cost of labour.

A return of inflation changes how assets are priced and where you should invest

Finally, we are seeing a reversal in the decades-long increase in globalisation.

The rise of China as the world's factory has helped keep prices low for years.

After the disruptions caused by Covid, as well as changes that have recently occurred in China, many politicians and CEOs have concluded their dependence on China has gone too far.

The reaction may reduce the fragility of the global system, but it will also push prices higher.

Now it’s important to remember inflation has not been an issue in the developed world for decades.

The return of inflation will change how assets are priced, as well as how you should invest.

So far, our inflation rate has stayed surprisingly low. But you cannot reasonably expect this to last in an interconnected world.

The most critical thing right now is to make sure you’re not sitting on excessive cash balances.

You’ll feel the impact on your spending power long before the local headlines start hitting the mainstream news media. By then it will already be too late.

Instead, you need to look at inflation linked assets. That means holding onto things that will grow as the value of your cash money falls. In this situation, cash is NOT king.

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So, what should you do with your cash to protect against inflation

You should be looking at buying assets that have prices that will inflate.

Both stocks and property will act as inflation hedges, but only if you’re buying the right parts of the market. And, since rising inflation also means rising interest rates, your residential property (which is sensitive to interest rates as mortgage affordability is called into question) is probably not the place to park your cash.

In fact, I have real reservations around traditional property investments, but that is perhaps an article for another day.

I think you should look for defensive businesses with low gearing. You’re looking for businesses with great products and strong track records.

What does the US inflation figure mean for your portfolio?
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