On Tuesday morning we learned that the Bureau of Labor Statistics’ Consumer Price Index “CPI” rose by the most in over a year in May by 0.3 percent. This comes after last week’s slight announcement that the Producer Price Index “PPI” fell slightly, although keep in mind that consumer prices lag producer prices. Regardless of the slight decline in the PPI last week the overall trend in prices indicates that inflation is starting to pick up, and as investors we need to be ready.
However preparing for inflation is more than simply buying “real assets.” Many investors assume that in an inflationary environment it makes sense to indiscriminately own stocks, commodities, and real estate. But there is a problem with this approach. Stocks typically underperform in the aggregate in an inflationary environment because many companies see rising input costs with inflation that they can’t pass on to consumers without jeopardizing sales.
Furthermore, several commodities are economically sensitive, such as copper. If inflation picks up and the economy weakens as a result the demand for copper will decline, and this will send the price lower, or at the very least it will restrict the ascent of copper prices so that it underperforms inflation. Finally while real estate is a “real asset,” keep in mind that real estate is heavily dependent on interest rates, which rise if people fear inflation because they demand a higher return on their investments.
Given these considerations I have compiled a list of funds that investors should consider for an inflationary environment.
1. Proshares Ultrashort Lehman 20+ Year Treasury Bond ETF (TBT)
If inflation picks up then interest rates will likely rise. This means that bond prices will fall, including Treasury Bonds. Furthermore, long-term debt is more vulnerable to a bear market as longer term bonds carry more risk. So in an inflationary environment investors should consider betting against long term bonds, and the TBT is an excellent way of doing so. This fund trades inversely to long-term Treasury Bonds and it offers 2X leverage. That means if bond prices fall 1 percent the fund rises 2 percent. The patter is reset on a daily basis so this leverage can potentially compound to more than 2X if you get a long string of days where the long term Treasury market falls. But it can backfire—even if bonds trade flat then the fund will slowly lose value. So this is a trading vehicle, which, if used tactfully can generate significant returns over a short period of time.