High inflation investing

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Big Taco's picture
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Joined: 2006-11-16

I think it's very important for a long-term investment portfolio to perform in a way that (on average) exceeds the rate of inflation. 
So in light of the news that November was a month when inflation rates rose, I've been thinking about investment strategies that would make sense if inflation suddenly got out of control like in the early eighties.
 
Any thoughts on important considerations/strategies and investment products or asset classes that help investors' money keep up (or ahead) of the rising costs of goods and services in a high-inflation economy?

doberman's picture
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Joined: 2005-02-22

I don't think we're just having high inflation, I believe we're experiencing "stagflation" (low or no growth with high inflation). I subscribe to the website www.shadowstats.com which provides some rather shocking revelations about our economy. (Yeah, I know the website name smacks of conspiratorial boogaboos, but his economic measurements are good.) The basic premise of the site is to provide economic measurements using the standards in existence, prior to the fudging and manipulation of these standards by previous presidential administrations. For example, using standards for measuring CPI prior to the '80's, would give us a current annual inflation rate of 10%+. Also, based on previous standards of measurements, we've had negative GDP growth for several quarters, now. And our unemployment rate is really over 10%.
 
When I came across these numbers, suddenly, a lot of things started making sense: the run-up in the price of gold, the dollar dropping in value, the Fed's lowering of rates, etc. These are not typically the characteristics of a "strong" economy. 
 
How to invest? Very conservatively! Because the inflation rate is high, you have to be invested in stocks. I have recommended a higher overseas allocation, with a large percentage in international blue chips and a small percentage in dividend-paying stocks of emerging markets. If clients are hesitant about overseas investing, then I put as much as I can in US-based companies that have a significant presence overseas.
 
What about the market continuing to go up, despite all these "real" economic numbers? One word, liquidity. The market will continue to go up, as long as the Fed continues to throw money at it. The Dow could easily hit 100,000, with high inflation and a very weak dollar. However, the real question is, how much of that 100,000 reflects real economic growth and how much is simply inflation? (Real Growth = GDP minus Inflation)
 
Want to get the attention of your clients who receive Social Security? Just tell them that if the CPI was measured the same way it used to be, they'd be getting 10%+ annual increases the past few years. (Oh yeah, the Clinton Administration made the most radical changes to the way the CPI is measured, with Bush making a few tweaks of his own.)
 
Yeah, yeah, I sound like a nut job. So, do your own due diligence.

troll's picture
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Joined: 2004-11-29

Interesting stuff dobe....

Big Taco's picture
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Joined: 2006-11-16

Good stuff, Doberman. 
 
I've been thinking for a long time that especially with rising energy costs, that inflation has been going up more than 4%/yr. 
 
I checked out the website you linked to, also.  Is there any way you can elaborate on some of the changes that the CPI has gone through since the 80s? 
 
You wrote that in an extreme inflationary period it's important to invest "very conservatively", but then you go on to write that a person should invest in stocks (albeit more conservative "blue chip" type companies).  When I hear "very conservative" investing, I automatically think of fixed income.  I realize that usually CDs will only help your money keep up with inflation (if we're assuming inflation is still around 4% avg, which very well may not be the case), but in a period like the early 80's where inflation breached 17%, does it make sense to just try to keep up with it (hold on for dear life) with CDs, or does it still make sense to invest in equities which may dramatically underperform a high inflation rate in the same period? 
 
When older clients wax nostalgic about when they could buy 16% CDs, I always try to drive the point home that at that same time, inflation was out of control, and they surely weren't making up too much ground.  Since personal finance was of no concern to me in the early 80's, I don't have experience with investing client's money in high inflation periods.  I also admittedly haven't researched this much, as I see it as just a hypothetical right now.  But... Wouldn't it make sense if we experience this sort of runaway inflation again to buy long term bonds and CDs, so that even when the inflation rate returns to the mean, clients can hold on to these fixed investments with high ror and are locked into this return?

doberman's picture
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Joined: 2005-02-22

Big Taco wrote:Good stuff, Doberman. 
 
I've been thinking for a long time that especially with rising energy costs, that inflation has been going up more than 4%/yr. 
 
I checked out the website you linked to, also.  Is there any way you can elaborate on some of the changes that the CPI has gone through since the 80s? 
 
Sure, but I can't do the subject justice like the website can. The website sponsor does offer free downloads of archived materials that explain, in detail (and much better than I), the changes that have taken place. In fact, many of these changes are on various gov't websites (hiding in plain view). The only thing that isn't free are his current economic measurements. So far, I'm pleased with his site and the information he provides. Ok, an example of just one CPI change: Prior to the '80's, the CPI simply measured a basket of goods, like the price of steak. If the price of steak went up 10%, that was figured in the CPI. Then one of the presidential administrations decided to implement the "substitution" rule; whereas, if the price of steak was too high, consumers would simply buy hamburger, instead. So, the (lower) price increase of hamburger was substituted for the higher price increase of steak. This rule was implemented across the board, for most everything in the CPI basket. The CPI now measures the rising cost of a declining standard of living.
 
An example of a change in the GDP: Used to be that if $5 billion of computers were sold in the US, that $5 billion was included in the GDP. However now, using computers of the late '80's / early '90's as a baseline, if $5 billion of computers are sold this year and they're 5 times faster than the baseline computers, then $25 billion is added to the GDP. 
 
You wrote that in an extreme inflationary period it's important to invest "very conservatively", but then you go on to write that a person should invest in stocks (albeit more conservative "blue chip" type companies).  When I hear "very conservative" investing, I automatically think of fixed income.  I realize that usually CDs will only help your money keep up with inflation (if we're assuming inflation is still around 4% avg, which very well may not be the case), but in a period like the early 80's where inflation breached 17%, does it make sense to just try to keep up with it (hold on for dear life) with CDs, or does it still make sense to invest in equities which may dramatically underperform a high inflation rate in the same period? 
 
Yeah, I should have better explained that statement "very conservatively". I meant high quality companies with a significant international presence. My portfolios are very plain vanilla, no shorts, no structured notes. Of course, you can only invest in a way that makes the client comfortable. If bonds are the only way they feel comfortable, so be it. However, I'll crawl on broken glass to get a client to have, at the very least, a partial exposure to international dividend-paying blue chips.  
 
When older clients wax nostalgic about when they could buy 16% CDs, I always try to drive the point home that at that same time, inflation was out of control, and they surely weren't making up too much ground.  Since personal finance was of no concern to me in the early 80's, I don't have experience with investing client's money in high inflation periods.  I also admittedly haven't researched this much, as I see it as just a hypothetical right now.  But... Wouldn't it make sense if we experience this sort of runaway inflation again to buy long term bonds and CDs, so that even when the inflation rate returns to the mean, clients can hold on to these fixed investments with high ror and are locked into this return?
 

It's only natural to think in terms of "principal-protection" during times of risk. However, what I try to get across to my clients and prospects, is that we're past that point and they must now focus on "purchasing power". You mention "when the inflation rate returns to the mean". However, I don't see that happening for years or even decades. Why? Four reasons: Social Security, Medicare, Medicaid, & the new prescription drug coverage plan; which will cost us $45-$50 trillion dollars over the next 20-30 years. We can't afford that, period. The possible politician's solution? Print more paper money and throw it at the problem. Inflation will continue, in my opinion.
 
Listen, there's no way to get a handle on this problem from my post. There are people more knowledgeable than I, who can better inform you. I often refer to the FREE website www.prudentbear.com and read their articles. The latest book I've read, dealing with these problems, is "Crash Proof Your Portfolio", which is good. After a while, you'll be able to pick-out the nut jobs from those raising very serious, very valid verifiable points.
 
With all this being said, what is important for you and your clients is that you're aware of these economic measurement changes that have taken place. The future implications of these changes are a matter of opinion and you may form your own. My bottomline reaction to these changes is to stay conservative (in my stock investments and recommendations) and plain vanilla, high quality everywhere else.

Ashland's picture
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Joined: 2007-03-07

I recently did a look at a company's (recently in the news a lot) 5 yr rolling performance since the late 1970's & found some interesting stuff. In almost all of the periods this company's dividends went up by >100%(at one point it had to cut its dividends, but the dividends had risen to their pre-cut level in 3 - 4 yrs)! In almost all of the 5 yr periods this company's stock price(after div's & splits) stayed pretty close to where it started - a few up and few down(of course the 90's were awesome!). I'd love, tho, to be that investor who was able to capture that growth in income(or reinvest) while keeping my principal relatively stable. I also think that investors ought to be thinking in 5 yr - 7 yr periods at the minimum if they're investing in stock allocations = or > 50%. In these time periods these G&I investments seem to make a lot of sense.

Here's my table for rolling 5 yr periods for its' stock price since '77.

5yr Rolling Periods     
1977-1982     -21.21%
1978-1983     28.51%
1979-1984     37.42%
1980-1985     79.65%
1981-1986     197.37%
1982-1987     33.82%
1983-1988     77.51%
1984-1989     16.87%
1985-1990     -9.50%
1986-1991     6.75%
1987-1992     13.02%
1988-1993     261.58%
1989-1994     202.27%
1990-1995     274.25%
1991-1996     653.33%
1992-1997     891.88%
1993-1998     536.10%
1994-1999     527.75%
1995-2000     850.77%
1996-2001     396.32%
1997-2002     149.02%
1998-2003     75.76%
1999-2004     95.26%
2000-2005     16.53%
2001-2006     8.83%
2002-YTD07     -26.87%
Median     78.58%

Big Taco's picture
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Joined: 2006-11-16

Really good post, thanks Doberman.
 
I didn't realize there is free downloads on the inflation site, I thought it was all subscription, so I'll have to check that out.
 
I still have a question on investment strategy which may sound noobish, but eitherway:  If we're in an economic climate where we can get low risk, longer duration bonds or CDs that are yielding 10 or 15% like in the early 80s, then isn't it smart to buy these for clients as part of their fixed income allocation so that even after the inflation rate (hopefully) reverts to a lower level, they will still have these hi-yielding, low risk fixed income investments producing yields for years after?  I'm not suggesting 100% allocation to fixed, but if a client's asset allocaiton calls for say, 30% fixed income, then putting most of that into long duration, low risk, hi-yielding bonds.  What's wrong with this strategy?
 
Isn't this what a lot of whole life and universal insurance companies have done in their general fund?  Buy ultra longterm bonds back in the early 80s/late 70s which helped make the dividends from said insurance policies attractive?  Or am I mistaken here?

doberman's picture
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Joined: 2005-02-22

Big Taco wrote:Really good post, thanks Doberman.
 
I didn't realize there is free downloads on the inflation site, I thought it was all subscription, so I'll have to check that out.
 
I still have a question on investment strategy which may sound noobish, but eitherway:  If we're in an economic climate where we can get low risk, longer duration bonds or CDs that are yielding 10 or 15% like in the early 80s, then isn't it smart to buy these for clients as part of their fixed income allocation so that even after the inflation rate (hopefully) reverts to a lower level, they will still have these hi-yielding, low risk fixed income investments producing yields for years after?  I'm not suggesting 100% allocation to fixed, but if a client's asset allocaiton calls for say, 30% fixed income, then putting most of that into long duration, low risk, hi-yielding bonds.  What's wrong with this strategy?
 
Isn't this what a lot of whole life and universal insurance companies have done in their general fund?  Buy ultra longterm bonds back in the early 80s/late 70s which helped make the dividends from said insurance policies attractive?  Or am I mistaken here?
 
Certainly, if I could find a SAFE CD or bond yielding 10%-15%, it would form part of the core of my clients' portfolios. Unfortunately, they can't be had. The only CD's or bonds that (now) offer the potential to earn such a high of a return (interest + currency gains) are international bonds, but they're also subject to currency risk.
 
As a hedge, some consultants put their clients into inverse funds, gold, precious metals, commodities, international stocks & bonds, etc. I'm not smart enough to predict which one will be best and, usually, it depends on the client's circumstances and whatever they're comfortable with owning. I prefer plain vanilla; i.e., rather than own the product (ex: gold), I'd rather own the dividend-paying company that produces, mines, etc. the product.
 
As far as insurance companies and their portfolios, I can't say.

doberman's picture
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Joined: 2005-02-22

Oh yeah, another service provided by the website is that he provides M3 data which the Fed stopped providing months ago. For those who don't know, M3 is an indicator of money supply. A large M3 supply is usually a cause of high inflation (excess dollars).
 
His numbers currently indicate a very large M3 (surprise, surprise).
 
 
 

Big Taco's picture
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Joined: 2006-11-16

Something seems very wrong about a government that continues to escalate secrecy.  From M3 numbers to destroyed "Enhanced Interrogation Techniques" videos, these are worrisome indicators, but of what exactly I'm not sure.
Yes, of course we can't buy 15% CDs right now.  I was hypothesizing as if we are in an economic climate where these financial products would be available like in the early 80's. 
Thanks for the info, Doberman.

doberman's picture
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Joined: 2005-02-22

You're welcome, Big Taco. And Happy Holidays to you and everyone on the boards!

troll's picture
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Joined: 2004-11-29

doberman wrote:Big Taco wrote:Really good post, thanks Doberman.
 
I didn't realize there is free downloads on the inflation site, I thought it was all subscription, so I'll have to check that out.
 
I still have a question on investment strategy which may sound noobish, but eitherway:  If we're in an economic climate where we can get low risk, longer duration bonds or CDs that are yielding 10 or 15% like in the early 80s, then isn't it smart to buy these for clients as part of their fixed income allocation so that even after the inflation rate (hopefully) reverts to a lower level, they will still have these hi-yielding, low risk fixed income investments producing yields for years after?  I'm not suggesting 100% allocation to fixed, but if a client's asset allocaiton calls for say, 30% fixed income, then putting most of that into long duration, low risk, hi-yielding bonds.  What's wrong with this strategy?
 
Isn't this what a lot of whole life and universal insurance companies have done in their general fund?  Buy ultra longterm bonds back in the early 80s/late 70s which helped make the dividends from said insurance policies attractive?  Or am I mistaken here?
 
Certainly, if I could find a SAFE CD or bond yielding 10%-15%, it would form part of the core of my clients' portfolios. Unfortunately, they can't be had. The only CD's or bonds that (now) offer the potential to earn such a high of a return (interest + currency gains) are international bonds, but they're also subject to currency risk.
 
As a hedge, some consultants put their clients into inverse funds, gold, precious metals, commodities, international stocks & bonds, etc. I'm not smart enough to predict which one will be best and, usually, it depends on the client's circumstances and whatever they're comfortable with owning. I prefer plain vanilla; i.e., rather than own the product (ex: gold), I'd rather own the dividend-paying company that produces, mines, etc. the product.
 
As far as insurance companies and their portfolios, I can't say.You also have to consider the sentiments of the investing masses, which is frequently wrong.  I knew a few guys who were active in the business back then.  He said most corporate bonds were callable because the finance guys were smart enough to realize that if inflation backed down they wanted to be able to call the bonds at a lower rate.  He said the only widely available non-callable bonds were longer Treasuries that were paying around 12-14%, but nobody wanted to buy them because with the inversion of the yield curve money markets and t-bills were paying more, and of course everyone expected that rates were going to continue to go up....He said you literally had to pull teeth to get people to buy them...

Big Taco's picture
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Joined: 2006-11-16

Yes, as usual with investing, there would really have to be a discipline of establishing that if LT Gov Bonds are available at 10% or higher, buy them and don't try to out guess if there is going to be a higher yeilding bond if we "just wait and see".  It's hard to do, IMO, and completely hypothetical at this point.

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