The prospect of looming inflation is cause for concern among investors. Potential tax cuts from the Trump administration may increase Americans' disposable income, encouraging more spending and with it, more inflation. Additionally, protectionist policies may increase the price of imported goods and raise domestic wages, furthering inflation concerns. While all the talk of inflation may sound ominous, modest inflation tends to be a good sign that the economy is growing. Investors may want to think about how to position their portfolios to help protect against the growing risk.
Inflation and stock prices – buyer be aware
So, what are the consequences of inflation when it comes to investing? If a company is valued accurately, stock prices should reflect fundamentals. However, in times of rising inflation, stock prices may rise simply because all prices are rising, rather than the company's fundamentals supporting rising valuations. Investors typically look at price-to-earnings (P/E) ratios as a gauge of what investors are willing to pay for a share of a company per dollar of that company's earnings. According to FactSet, P/E on the S&P 500 is nearly 18 percent higher than the five and 10-year averages, indicating that stocks across the board are very richly valued. This may point to the need to insulate your portfolio against inflationary pressures.
Commodities as inflation fighters
Given concerns about high valuations in the markets, investors may want to consider looking to diversify their portfolios with an eye towards vehicles – outside of stocks and bonds – that may help protect against inflation. Commodity investing, for instance, can help diversify a portfolio and provide a potential hedge against inflation. The commodities market is filled with value in the form of hard assets, which tend to be negatively correlated with stocks and bonds.
There are a number of ways investors can gain exposure to assets ranging from precious metals, like gold and silver, to agricultural goods, like corn, livestock and sugar, to industrial materials, like copper and iron ore. Commodity-backed ETFs are a good way to gain initial exposure to this part of the market, while savvier investors may consider buying futures contracts for specific commodities. Investors interested in physically owning commodities like precious metals can look to specialty banks or brokerages that provide direct purchasing opportunities.
Diversifying with commodities – where to start
There are a number of commodities like gold, sugar and copper that demonstrate promise over the long term. For starters, gold is typically recognized among the commodities as a solid long-term investment. While past performance is not a guarantee of future results, gold has historically maintained its value over time and it serves as a potential hedge against inflation. With inflation, since the price of gold is valued in U.S. dollars, the value of gold tends to increase. Additionally, many investors typically believe gold will hold its value better than other assets as prices of goods and services rise. Gold can also be viewed like a form of insurance to potentially help protect a portfolio against adverse global events, given its tangible value.
The production of sugar has become more stable and geographically diverse, with cane and sugar beet facilities operating across more than 120 countries. Sugar is utilized in a variety of both food- and non-food applications, from serving as a sweetener and preservative to textile finishing, wound healing and producing detergents and pharmaceuticals. Growth in the sugar market has historically been concurrent with rising global per capita income levels and an expanding middle class, providing a sweet spot for investors.
Most recently, we have seen this driven by emerging market economic expansion in China, India and Latin America. As income levels rise in these areas, diets have tended to shift toward foods with a higher sucrose level, such as soft drinks and processed foods, thereby increasing demands for sugar. These demographic shifts are compounded by the fact that sugar stock levels are low due to decreased production and recent poor weather conditions in major supply countries Brazil and India. This combination has caused prices to continue to strengthen, a trend that could continue into the foreseeable future.
Another commodity to consider is copper, an important component in both construction and industrial applications. The construction boom in both the U.S. and abroad requires significant copper output as buildings are fitted with wiring and plumbing. In places like China and India, where whole swaths of commercial and residential communities are under development, copper looks to remain in demand. In addition, due to its unique, low-cost electric conductivity capabilities and high thermal properties, industrial manufactures are also driving demand.
Commodities a safe haven against inflationary pressures
As with any investing approach, the key to commodity investing is diversification. By speaking with your bank or financial advisor, you can determine how to best spread allocations across multiple sectors that show promise. You can also discuss pros and cons of the various vehicles you can use to invest in commodities. Ultimately, your overall portfolio may benefit from commodities in the wake of inflationary pressures. If inflation picks up, you won't be running for safe havens.
Commentary by Chris Gaffney, president of the World Markets division of EverBank.
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