From Penny Candy To The Dollar Menu – The Impact Of Inflation On Markets

By the end of September, we saw worldwide food costs increase for the fourth straight month. This has become particularly cumbersome in developing nations like India, where annual inflation rose above 7% during the same month, while food prices jumped nearly 10%! Globally, central bankers have tried to walk the delicate line of stimulating their economy, while avoiding significant inflation. Food prices, as well as the cost of other essential goods and services, will likely continue this upward trend. Just as penny candy at Woolworth’s faded away decades ago, so too will the famed promotional “dollar menu” at our favorite fast food joints as costs increase. As the website for the Center of Economic Policy Research recently stated, “The coronavirus pandemic, and the supply shock that it has induced, will mark the dividing line between the deflationary forces of the last 30 to 40 years, and the resurgent inflation of the next two decades.”

Not too long ago in April 2019, the cover of Businessweek asked, “Is Inflation Dead?” emblazoned above a picture of a deflated dinosaur. Certainly, this harkens back to the famous magazine cover in 1979 declaring the “Death of Equities,” which was the contrarian message of an investor’s lifetime. I would argue that inflation now has some wind at its back. In the U.S., whether before or most likely after the election, we will see more significant fiscal stimulus. Frankly, I would term the fiscal action to date as “support”, rather than stimulus, as it has simply replaced lost incomes. Remember, as Milton Friedman used to quip, “Nothing is so permanent as a temporary government program.”

Furthermore, as global supply chains move from “just-in-time” inventory to “just-in-case”, we will see a continued shift to deglobalize. The WSJ recently referenced economist Doug Irwin, stating “in the past, when domestic production couldn’t meet demand, importing from abroad was possible to bridge the gap.” In an era of deglobalization, this becomes much more difficult and will result in inflationary pressure. Economics is the study of scarcity, as Dave Iben states, and during this coming decade, a main priority for investment portfolios should be inflation protection.  

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As many money managers prefer to follow the herd and avoid “career risk”, investors will continue to see the traditional 60/40 portfolio mix (60% equities / 40% long bonds) with a hefty allocation to index funds — until that stops working, of course. We have seen recently that the reliable link between stocks and long-term government bonds that defined a “popular investment strategy for decades has broken down this year.” The 60/40 portfolio works best when there is good economic growth and low inflation — a favorable mix which we are less likely to see for the foreseeable future.

In addition to the traditional mix, it is interesting to perceive indexing as a new form of socialism. Louis Gave recently stated that with indexing “capital is not allocated according to marginal return – the foundation on which capitalism rests.” Instead, capital is allocated based on the size of companies, like it was in Soviet Russia. Illogically, investors perceive this strategy as safe. In the last few weeks, it was reported that Harvard’s endowment was spinning out its natural resources team. This portion of their portfolio, much of which they began acquiring over ten years ago, will enter runoff mode at the precise time they should likely add exposure.

While owning companies with high barriers to entry and significant pricing power, complemented with gold and short-term liquidity may be the right approach for portfolios, it may not be the most popular today. Gold, for example, is the inverse of trust in the monetary system. Almost 20% of all outstanding US dollars were essentially created in Q2 2020, therefore owning an asset such as gold serves as an insurance policy. John Kenneth Galbraith’s famous observation was that “it is far, far safer to be wrong with the majority than to be right alone.”

The Rosenau Group is a team of investment professionals registered with HighTower Securities, LLC, member FINRA, SIPC & HighTower Advisors, LLC, a SEC registered investment advisor. This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of HighTower or its affiliates. This is not an offer to buy or sell securities, and HighTower shall not in any way be liable for claims related to this writing, and makes no expressed or implied representations or warranties as to its accuracy or completeness. 

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