Are you ready for inflation? Really ready?
You can be forgiven for thinking the recent focus on inflation is overdone. In fact, many financial personalities now warning about inflation have been doing so for more than a decade and the exact opposite has happened.
Despite hyperbolic warnings that often reference Germany’s Weimar Republic and urging for a return to the gold standard, these concerns have never materialized in a meaningful way.
In fact, we’ve struggled to maintain the 2% target inflation the Federal Reserve desires. Yes, that’s right—the federal government wants inflation. A moderate amount of inflation is ideal as deflation tends to lead to low economic growth and a postponement of economic activity as consumers wait for continual lower prices.
Are these inflation hysterics right this time? Well, even a broken clock is right twice a day. Here’s what we know: prices are starting to rise at a faster pace than in recent years. Even corporate executives are increasingly mentioning inflation as a key concern, mentioning it more than at any time since 2011 during earnings calls this year and 800% more than last year!
Critical commodities and semi-finished products have exploded since the onset of the pandemic.
- The price of lumber has risen more than 300% in the last 1-year period and has added nearly $40,000 to the cost of a new single-family home.
- Gasoline prices are up 9% in March over the prior month according to the U.S. government’s CPI index. The price of crude oil has increased 40% since the beginning of the year.
- The price of copper has surged to levels not seen in nearly a decade and is up more than 30% year-to-date.
The Main Inflation Question: Is It Temporary?
The issue for investors is if this is a temporary concern or whether inflation is here to stay. The Federal Reserve currently feels the former is more likely due to supply disruptions that occurred due to COVID’s effects on production. The U.S. central bank argues that demand came back significantly more rapidly than many businesses expected, and it will take some time to produce the materials needed to balance demand.
Bloomberg reports that forecasting firm IHS Markit estimates these price increases to abate later in the year and Blackrock Investment Institute wrote Monday that they see U.S. consumer-price increases averaging slightly under 3% from 2025-2030.
However, even these firms could be underestimating inflation as governments around the world are planning on huge-scale infrastructure spending, interest rates remain historically low, and the private sector races to capture “forced savings” acquired during the pandemic.
How to Invest in Inflationary Times
Ultimately, the reason people invest is to produce real (aka inflation-adjusted) returns. Therefore, higher inflation levels require higher total returns to maintain the same amount of purchasing power.
Some asset classes perform better in inflationary environments. Investments like fixed income bonds tend to underperform as inflation erodes returns. Additionally, higher-coupon bonds must be issued to induce investors to buy, which makes lower-coupon bonds worth less.
Investments that are positively correlated with inflation are real estate, commodities (like those mentioned above), precious metals, and stocks.
However, all stocks are not created equal and will react differently to inflation. Many commodity producers like miners and producers directly benefit from higher prices on their products. However, mining companies are generally price takers and lack pricing power.
Another group of stocks that outperform in inflationary environments are companies with large balance sheets. Inflation is an erosion of the dollar, which makes debt more manageable and increases the market value of assets like buildings.
Fixed-rate debt becomes cheaper for these companies with higher levels of inflation. Real estate investment trusts are often mentioned as stocks that benefit from inflation as their primary asset is real estate and these companies tend to hold above-average levels of debt.
However, one of the best ways to invest in inflation is through companies with clear market leadership. With market leadership comes pricing power and these companies are often able to control supplier expenses while being able to pass along any price increases to their customers.
Where to invest $500 right now
Are you ready for “maximum upside?”
Motley Fool Rule Breakers is led by legendary investor David Gardner and pinpointed Tesla at $6.29, Salesforce at $6.89, and Shopify at $21.02. (It trades for more than $1,000 per share today!)
Here’s why you’ll want to get the full details on Rule Breakers today. The service just announced its top 10 “best buys now” across the entire stock market. Whether you’re starting with $100, $500, or more, you’ll want to get the full details!
3 Investments That Should Crush Inflation
Apple is the Market Leader
Market Cap: $2.2 trillion
Forward P/E: 27 times
Investors might dismiss Apple as too big to continue to reward investors, but that’s folly. The company recently posted top-line growth of 54% over the prior year with its second quarter results, smashing analyst expectations for revenue and profit.
However, those fearing Apple would be impacted by inflation need not worry just based on recent history. In 2007 the company debuted the first iPhone, which was ridiculed by then-Microsoft CEO Steve Ballmer for its price tag. Apple’s high-end phone cost $600 that year and was mostly subsidized by carriers.
Currently Apple fans have been willing to pay as much as $1,400 for the top-of-the line version of the phone with far fewer carrier subsidies. That’s pricing power!
Like all companies, commodity costs do impact Apple, but due to its position as a market leader, the company has been able to pass along those costs and continue to source critical components like semiconductors.
Commodity input costs will likely be less of an issue in the future on account of Apple’s plans to double down on revenue from services like Apple Music, Apple TV+, and Apple Pay. The company currently has more than 1.5 billion iDevices as a part of its installed base and has begun to monetize them through recurring revenue services.
As a secondary and smaller benefit, Apple is known for its huge balance sheet which includes its recently built futuristic Apple Park headquarters. Additionally, the iPhone maker wisely tapped the debt markets to avoid repatriating cash and paying taxes on foreign earnings and will benefit from that debt becoming cheaper.
Despite having more than $100 billion in debt, Apple receives more in interest and dividend income from its $200 million in short-term cash and marketable securities than it pays on its debt. Inflation will allow Apple to eventually make more from its short-term investments as rates increase to address inflation.
Finally, investors can expect the stock to continue to outperform inflation in the long run. Apple continues to grow revenue and earnings at a rapid pace, has increased cash returns including share buybacks and dividends, and is well situated to pass along any price increases to consumers.
American Tower is an Innovative REIT
American Tower (AMT)
Market Cap: $110 billion
Dividend Yield: 1.9%
Real estate investment trusts, or REITs, are an interesting asset class for inflationary environments. Not only do REITs provide a level of diversification versus stocks, but they are also the easiest way to own property. Real estate is often considered the most effective pure-play inflation hedge because, as Mark Twain quipped, “They aren’t making it anymore.” Oh, did I forget to mention most REITs pay above-average dividends?
Inflation will boost all property values, and most REITs will benefit, but growth investors should investigate American Tower’s opportunity. Major wireless companies like Verizon, AT&T, and T-Mobile are rushing to build out 5G connectivity, which requires a significant investment in communication towers.
These companies could certainly build new towers—and they do—but they also lease tower space from American Tower due to its significant network and the fact that the infrastructure is already built. In fact, American Tower owns nearly 200,000 communications sites—the physical tower bases and supporting land—that communication companies pay rent to use. An easy-to-understand analogy is to think of American Tower as a landlord for wireless antennas.
Yes, it’s a boring business but is highly stable with long-term contracts and high renewal rates. Here’s the kicker: American Tower has negotiated rent escalation clauses that generally include some inflationary index like the consumer price index.
American Tower stock underperformed during the pandemic and on pace with the overall market year to date. However, the company continues to raise the dividend every quarter. In fact, the company grew payouts 20% last year, nearly 10 times larger than inflation.
At first glance, the current yield of 2% might not raise your attention, but when you consider American Tower’s generous dividend increases (which the company has done every quarter since 2012), it looks more impressive. Look for the company to continue to boost its dividend above the rate of inflation as 5G growth and negotiated price increases lead to future revenue gains.
Bitcoin is 21st Century Gold
Market Cap: $1.05 trillion
Sorry goldbugs, but your time has passed. Despite the commodity’s reputation as an inflation hedge, its record has been rather spotty. Gold prices (USD) are nearly flat since September 2012 despite 15% inflation, and gold prices doubled from 2008-2012, yet inflation increased only 6% during that period.
Increasingly, a better inflation hedge is in the digital realm with Bitcoin. The fixed total supply of 21 million coins will serve as a check against any erosion in the dollar. However, it’s the second wave of bitcoin acceptance that has Millennial Money excited.
Bitcoin is moving beyond a traditional store of value to becoming a transactional currency. Look for adoption and demand to soar as more transactions are settled in the currency.
Tesla might have been the highest-profile bitcoin convert in recent memory, but it won’t be the last. In fact, fintech payment facilitators like Square and PayPal are moving to support payments in the cryptocurrency that will only serve to increase demand.
Unlike gold—which has been around for millennia and still has little utility as a transactional currency—bitcoin has quickly moved from inception to near ubiquity and became the fastest asset to reach a $1 trillion market cap by doing so in 12 years.
Bitcoin certainly has its detractors, most notably Berkshire Hathaway leaders Warren Buffett and Charlie Munger, who have called it “poison squared” and “disgusting,” respectively. However, the investments into the infrastructure and the token itself show bitcoin is here to stay.