The Prospect of High Inflation Eating Equities Alive

There are some parts of the work scope that is not part of the official work scope. One of them I feel is to anticipate what would pre-occupy the minds of an average client.

If you think like a wealth builder that is starting off, then you might be able to be more attuned to what they would be asking.

They might not be asking it today, but at some point in the future, they might start asking.

The issue is that you might need some time to find out these answers. I would classify doing this as a proactive kind of risk management process.

With so much money printing in the world, there would be enough people wondering about what are the solutions if high inflation were to rear its ugly head again.

The most “sensible” solution is gold, silver, commodities, bitcoin, mining companies, commodities-related companies.

Buffett Seems to be Thinking About Something

Warren Buffett recently just sunk a small part of his money in Barrick Gold, after saying so long publically negative things about gold.

But watch what he do not what he says.

This week, we found out on his 90th birthday that he also took 5% stakes in the five largest “Trading houses” on the Japanese stock market. Warren from time to time, have invested in international companies. So him doing this is not new.

What we can learn from these great investors are what they say but also what they do. And you can only appreciate it if they explain later. In this case, we have to guess why he choose to purchase these 5 companies.

One reason is that they are cheap. 4 out of 5 companies trade below their book value. They have decent dividend yields and their PE ratio hovers below 10 times (if you ask me for these kind of companies there is a reason why their PE should be below 10 times)

Another reason could be what they see on the horizon and they decide to take a bet on it. I am not sure about the thesis here. A weaker dollar leading to better risk versus reward in emerging markets, cyclical companies?

I think that is likely.

These trading houses deal with very traditional commodities like businesses. So I suppose he is of the view that these would do well.

Would the ETFs that You Own Fare Badly?

In any case, some may interpret that higher inflation is on the cards and what can you do about it.

The usual suspects would be the solutions that I wrote above.

But I think many people may not realize that their portfolio is already setup to hedge against inflation.

You have equities in your portfolio.

In How Did Stocks Perform During High Inflation Periods, I tried to find out how equities did in possibly the worst retirement sequence in our history.

This is the period starting from 1966 to 1986. The reason why this period is challenging is that you can imagine the normal foodstuff that you absolutely must eat going up by 6% on average in these 20 years.

Your spending will kill your portfolio.

My research shows that equity do rather decent during that scenario:

How do stocks perform in high inflation periods 4
Growth of $1 million for different UK indexes versus US consumer price index and personal consumption expenditures

This is a weird comparison crossing two different countries but I wanna show that this equities outperformance is not localised to just the US market.

You can read more about it in the article.

How well your ETF would do will depend on whether you can capture the performance of the sectors or countries that are performing the best.

How can we explain this phenomenon?

Well, if you look at the China or emerging market indexes today, it looks very different from the emerging market indexes 10 years ago. Back then, it was dominated by trading companies, commodities-related companies, financial companies.

Today they are dominated by tech companies.

Companies get more valuable and take a larger proportion of the index. Companies faced challenges and take a smaller proportion of the indexes.

The beauty of owning a portfolio of stocks in say in a few emerging markets is that you capture both the returns and the risk of these region.

If that inflation scenario rear its head, the supply and demand dynamics, the fat profit margins due to the operating leverage of these mining companies, the weakness of these growth companies, may result in these tech companies taking a backseat versus some of these companies (key word is May because we do not know the magnitude of these changes)

If you want a more recent example, look at how well the Malaysian stock index have been doing recently versus the Singapore stock index.

What was different? We owned stocks that faced challenges in this environment. Malaysian stock index contains rubber, glove companies which shot through the roof because of the sudden, massive shift in demand and supply dynamics.

There are usually not just one solution to a problem like high inflation. It is just the efficiency of things.

So maybe, you should be less worried. If it ever rears its ugly head.

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