Harvey Jones
23.11.2021

Inflation is back - here’s how to protect your portfolio
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What goes around comes around, they say, and after a break of more than 40 years inflation is finally heading our way.
Many investors have never experienced a bout of inflation, and don't know what to expect.
Those who lived through the "Great Inflation" of the 1970s do know, and they are worried.
Inflation is like a silent tax on wealth. It destroys savings and savages incomes, and hits pensioners especially hard.
So with US consumer price growth hitting 6.2% in October, it's worth taking a step back in time to see how the different asset classes performed during the 1970s, and how they may fare today.
I'll start with the easy bit. Cash.

Inflation eats cash
Savers have suffered from more than a decade of near-zero interest rates and if inflation takes off, their plight is going to get even worse.
If you get 1% on your savings and inflation averages 6%, the spending power of $1,000 will be eroded to $950 after one year.
If central bankers hike interest rates to keep the lid on inflation then savings rates may rise, but it won’t be anywhere near enough to keep up with inflation.
Cash feels safe, but it isn’t, especially now. All it does is guarantee that the value of your money will erode in real terms.
So what about that other low-risk investment favourite, government and corporate bonds?

Bonds: high risk, no return.
Bonds do badly when inflation is climbing, because they pay a fixed rate of income that rapidly erodes in value.
As a result, investors demand a higher rate of interest on newly issued bonds, but here’s another catch.
When yields rise, bond prices fall. Nobody wants to be at the sharp end of a wealth-destroying bond market crash.
I’ve been looking at bond performance in the 1970s, and it doesn't look promising. In 1974, US inflation hit a staggering 11.05%. That year, 10-year US government bonds, known as Treasuries, yielded 7.56%.
That is high by today’s standards, but investors still got a negative yield in real terms. The value of their money fell by 3.49% that year, and as the table below shows, it dropped another 1.15% the next year.
Bond investors did not lose every year. Yields outpaced inflation for the next few years but plunged back into negative territory when inflation returned at the end of the decade.
In 1980, US inflation peaked at 13.55%. The same year, US 10-year Treasures yielded 11.43%.
This does not mean you should abandon bonds altogether, but may want to reduce your exposure.
Another option is to invest in inflation-linked bonds, such as US Treasury Inflation-Protected Securities (TIPS). These should rise with prices and you can invest in them via an exchange traded fund (ETF).
Popular names include Vanguard Short-Term Inflation-Protected Securities ETF, which currently yields 2.26%, iShares 5 Year TIP Bond ETF, which yields 3.60%, and SPDR Portfolio TIPS ETF, which yields 3.90%.
These rates are below today’s US inflation number, but easily beat cash.

How the main asset classes performed during the Great Inflation

Shares.
Stock markets do well when price growth is moderate, as this often correlates with positive economic growth and rising company profits.
However, when inflation lets rip the economy can get bumpy, as it did during great 1970s “stagflation”, stocks suffer.
In the 1970s, the FTSE All-Share rose by 56%. Unfortunately, the retail price index rose by an incredible 248%.
It is a similar story in the US. As my table shows, when inflation hit 11.05% in 1974, the US S&P 500 crashed 29.72%.
However, in 1975 the US S&P500 rebounded by a thumping 31.55%. It also fought off the 1979 inflation resurgence, climbing 12.31% against US inflation of 11.25%.
Naturally, some sectors did better than others. 1970s inflation was driven by soaring oil prices, so energy stocks did well.
The Invesco DB Oil Fund ETF, United States Brent Oil Fund and the ProShares K-1 Free Crude Oil Strategy ETF may be worth a look.
However, they have performed strongly lately, with the Invesco fund up 136% over 12 months, so you may have missed your chance for now.
Commodities generally are seen as a top inflation hedge. Investing in real, tangible assets is attractive when the value of paper money is falling. The Fed cannot print oil, gas, copper, iron ore, gold, silver, coffee or soybeans, only dollars.
Equity REITs (real estate investment trusts) investing in commercial property may also mitigate the impact of rising inflation.
Otherwise, look for companies with pricing power, or selling consumer staples such as food, toiletries, and so on.
Growth stocks such as big US tech firms may underperform, because their revenues will arrive in the future, when inflation will have eroded their value.
Banks may also struggle, because inflation erodes the present value of existing loans that will be paid back in the future.
Utility stocks also disappoint. As natural monopolies, they should able to pass on cost increases to consumers, but regulation often prevents that.
So what about the most famous inflation hedge of all?

Gold shines when inflation pours.
As 1970s investors lost faith in paper money, they raced into the oldest store of value there is. The gold price surged from $35 an ounce to more than $800 towards the end of the decade. It jumped 133.41% in 1979 alone, following the Iranian revolution, and Russian invasion of Afghanistan.
However, it soon crashed back below $400 and stayed around that level for 20 years.
There is another reason why you should be cautious about gold's anti-inflationary abilities. Today’s starting point is relatively high at $1,817, not that far below the all-time high of $2,034, which it hit in August last year.
Gold also faces a challenge from cryptocurrencies such as bitcoin, which some investors also claim are a hedge against inflation and currency debasement.
After a recent spike, the gold price has retreated slightly. Every investor should have some exposure, typically around 5% or 10% of their portfolio.
The simplest way to invest is through gold ETFs such as SPDR Gold Shares or the iShares Gold Trust.

Stay balanced even if prices rise
Today’s inflation panic may be “transitory”, as central bankers continue to claim.
As ever, the best way to face down the threat is by maintaining a balanced portfolio, that will perform in times of low inflation and high.

Harvey Jones has been a UK financial journalist for more than 30 years, writing regularly for a host of UK titles including The Times, Sunday Times, The Independent and Financial Times. He is currently the personal finance editor of the Daily Express and Sunday Express, and writes regularly for The Observer and Guardian Unlimited, Motley Fool and Reader’s Digest.

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