All the Conditions Are In Place for Inflation to Rise

It’s coming after your portfolio…

The majority of investors are not taking this threat seriously or preparing for it. And no, I don’t mean record stock valuations or ballooning corporate debt.

It’s a danger that Ronald Reagan once called “as violent as a mugger, as frightening as an armed robber, and as deadly as a hitman.”

I’m talking about inflation.

Every economics class in the world has covered inflation, but few people understand it. Inflation is mysterious, complicated, and hard to predict.

But when inflation strikes, it affects us all… Inflation reduces the value of money. When prices rise too high, it’s not good for the economy, as it leads to lower growth. It hampers those who live on savings and generate income from wealth.

Today, I think all the conditions are in place for inflation to rise…

To be clear, I’m not predicting hyperinflation – the phenomenon by which runaway prices render a currency worthless. But I do see inflation heading from today’s 1.3% level toward 3.5% or 4%.

That may not seem like much, but it adds up…

The difference between 1% inflation and 4% inflation is significant. Due to the power of compounding, a $100 weekly grocery bill turns into $110 over 10 years at 1% inflation… or $148 at 4%. If you spread that across all of your daily costs, retirement gets a lot more expensive.

What’s more, the expectations for inflation will drive investment returns. When you expect inflation, you position yourself differently than you would if you expect deflation.

In my income-collecting newsletter Income Intelligence, we have to constantly keep an eye on inflation. In the January issue, we dove into inflation and told readers why we expect to see it from here. Here’s what we said…

If you wanted to point to three sources of inflation, you’d look to accommodative monetary policy, expansionary fiscal policy, and a strong economy. There’s no question that we have the first two ingredients – and we think the third is about to kick in as well.

Monetary policy is obvious. The Federal Reserve is loose with money, and everyone knows it. The M1 Money supply – a measure of households’ most liquid assets or funds available for spending – is at an all-time high over $18.4 trillion.

As for fiscal policy, that’s obvious too. The Senate just passed the $1.9 trillion COVID-19 relief bill. This means cumulatively, more than $4 trillion will be injected into an economy that runs at a little more than $20 trillion per year…

The kicker to the inflation equation is a strong economy. Here’s more from that same Income Intelligence issue…

Consumer demand bids up prices on goods, services, and commodities.

A tight labor market leads to higher wages – raising costs to businesses along with the buying power of workers.

In our pre-pandemic assessment, the central point in our inflation prediction was the extremely tight labor market and upward pressure on wages.

Now, the economy doesn’t look the same as it did in late 2019… but it’s headed in the right direction.

Personal income is actually higher than its pre-pandemic levels. We didn’t just make people whole – we made them rich.

Personal income just shot up to $21.4 trillion, when it was only $19 trillion in January of last year.

Right now, the Federal Reserve says it’s not too concerned with inflation under 2%. While its target is 2% inflation, it’s now describing that as a midpoint, not a ceiling. The Fed will be happy with inflation at 4% – within two percentage points of its target.

I doubt the Fed will make a brash move to stem inflation… It raised rates too fast in 2018 – and the market outright rejected the decision.

Given all of these factors working together, my team and I have been calling for higher inflation. And it seems other folks are starting to agree.

But even if you know inflation is coming, what’s the best way to play it?

The most direct way would be to buy a Treasury inflation-protected securities fund, or TIPS. These are government bonds that are indexed to pay more when there is higher inflation.

TIPS are great if you’re looking for a highly safe, cash-like asset in your portfolio. But even with the protections against inflation, they are still low-yielding government bonds, so the returns will never wow you.

You should also be wary of most bonds for another reason…

Fixed-income instruments pay just that: fixed incomes. And when inflation reduces the value of each dollar, those income streams are worth less.

Finally, you can also bet on hard assets like commodities.

Examples of commodities are oil, gold, natural gas, sugar, and beef. They have historically been used as a way to diversify a portfolio away from stocks. Since they are tangible, commodities tend to hold up during times of economic volatility.

In the most recent issue of Income Intelligence, we noted in our Inflation Monitor that, “Oil, silver, copper, and corn all shot up this month, pushing commodities up around 50% on the year.” Today, commodities are still up roughly 50% from their 2020 lows.

We’ve always got to watch out for inflation, but today, it’s particularly important to keep your antennae up. It may seem like we’ve already got a lot to watch out for, but if you don’t inflation-proof your portfolio… your standard of living can feel the effects for decades.

Here’s to our health, wealth, and a great retirement,

— Dr. David Eifrig

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Source: Daily Wealth