Is it time to worry about rising prices?

June 16, 2011

The economy is still too weak for us to be worrying about inflation. That seems to be the majority view of economists, who are more focused on the prospects of a U.S. government default, a still-struggling housing market and unemployment.

“We don’t think there is a big concern now in terms of rising inflation,” Brad Sorensen, director of market and sector analysis for Charles Schwab, told me in an interview, echoing a common view. “With unemployment relatively high, there’s no wage pressure, and until we see that, there’s not a huge threat of inflation,” he said. “The bond market continues to not show any worry about inflation,” observes Charles Rotblut of the American Association of Individual Investors.

But prices are moving up. So-called core inflation (excluding food and energy) rose more than expected in May, posting its largest increase in nearly three years and surprising many who expected it to flatline. Consumer prices are now up 3.6 percent for the year ending May 31.

What I keep looking at is how fast inflation can move once it starts to snowball. The last time prices ran amok was in the 1970s. Consumer prices rose three percent in 1971, six percent in 1972 and 12 percent in 1973, according to Labor Department figures.

Individual investors are concerned about the prospects for rapidly rising prices, says Rotblut. And even sanguine experts like Sorensen see some seeds of inflation already out there in the Federal Reserve’s various easy money moves and in rising oil prices.

So the message for individual investors might be: Don’t panic. Prepare.

Here are a few ways to protect the value of your money from price hikes that could arise in the future.

Invest in stocks. Maybe that’s a hard sell, with the Dow Jones Industrial Average hitting its seventh straight week of red ink. But stocks do tend to at least keep up with inflation, according to an analysis from the National Association of Real Estate Investment Trusts. The Standard & Poor’s 500 stock index kept up with or bested inflation in more than half of the high-inflation periods since 1974.

Chose stocks carefully. Consumers facing job and price uncertainty are responding by spending more of their money on the essentials of life, says Lance Roberts, chief economist for Streettalk Advisors. Companies that profit on consumption of items that can be deferred — like clothing and cars — may not prosper anytime soon. Their costs could go up, and they won’t necessarily be able to pass those costs through to consumers in the form of higher prices.

What kinds of companies will be able to pass through costs? Technology companies, says Sorensen. That’s because businesses are spending some of their big pile of cash upgrading their systems and equipment, instead of hiring people.

Watch the real news. By which I mean, “real” interest rates, or the spread between interest rates and inflation. That’s because a first step in recovery could well be rising interest rates ahead of rising prices. If they diverge, people who have socked money away into inflation-protected securities like TIPs and i-Bonds can get hurt. The interest those bonds pay is pegged to the CPI, so they may not see yields rise. And their values can fall as other higher-interest bonds become available.

Think non-gold commodities. “I think gold prices are probably in a bubble, but a small allocation to other commodities wouldn’t hurt,” says Rotblut. “They do present a hedge against inflation.” Commodities (including gold) matched or beat inflation during 66 percent of those periods, NAREIT said.

And real estate. Yes, scary! But real estate investment trusts that invest in property (as opposed to  mortgages) met inflation in 66 percent of those periods. Rotblut suggests that homeowners avoid investing more in residential real estate, and instead focus on commercially-oriented real estate trusts.

Mix it up, but don’t go overboard. The best inflation-fighting portfolio was a blend of all of those categories, said NAREIT. A mix of 22 percent REITs, 28 percent commodities, 37 percent TIPS and 13 percent stocks matched or beat the CPI in 74 percent of those periods. Investors probably wouldn’t want to turn their whole portfolios over to inflation-fighting investments, while the experts profess to a lack of concern about inflation prospects. But a small allocation — just in case — could help lower anxiety.

4 comments

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You would have to pay me to take this advice in this market.

Run Forrest, run.

Posted by buddyboy | Report as abusive

Not much new here in terms of advice. Invest wisely is just an axiom that is hard to achieve even by the most sophisticated investor.

Posted by seattlesh | Report as abusive

I think some appropriate perspective needs to be injected here. 99.9% of the time, inflation would be a concern coming out of a recession. But two years out from the end of the recession and we’re still waiting for that inflation.

Right now, the Federal Funds Rate is targeted between 0 and 0.25%, and has lately been floating at 0.10%. Still, the economy lags behind the growth rate needed to reach full employment. We’ve been at this for over 2 years now, and without much inflation to speak of.

People are saying…gee when inflation hits, it’ll hit really bad. Maybe so, but the Feds have enormous slack to raise the rates when the current target is practically zero. I mean c’mon…the talk this month is of QE3, not of raising rates, and why? Because employment remains stubbornly low as demand is extremely weak.

So when the question is asked, “Is it time to start worrying about inflation”, I have to retort, “Don’t you think we should be worrying about employment?”

Posted by GRRR | Report as abusive

[…] Is it time to worry about rising prices? Linda Stern » More Analysis & Opinion […]

Posted by @mysistereileen.com @Reuters.com @wsj.com #PressDigest | News, Views and Reviews: Sid Harth | Report as abusive

Perhaps it’s time to step back and take longer views. The entire system is configured to address things on the time scales of re-elections. The arts of long-term planning for debt, savings, infrastructure, health, food, energy and population keep getting disregarded while “leaders” try to ensure their short-term popularity, putting out spot fires when there’s a great conflagration in the next room.

Posted by AltonBob | Report as abusive

[…] the idea that rampant inflation will trigger an investment debacle is perhaps overblown. A touch of inflation can be a good thing […]

Posted by Invsting: A little inflation isn’t such a bad thing | Reuters Wealth | Report as abusive