Dear Clients and Friends,
It has been an interesting quarter. I have seen a rise in the uncertainty level from investors over the last three months. The major US indexes are down about 12% since the beginning of April and European indexes are down slightly more - around 13%. As a result of all this uncertainty, when people find out I am an advisor, I frequently get questions about various markets. From, "What do you think about Greece?" to "Are government bonds still safe?" I imagine in good times people will be telling me about how great their investments have performed, but for right now, fear and uncertainty certainly seem to be the themes.
All that uncertainty can be uncomfortable. And there are big structural reasons for uncertainty: government stimulus ending, massive deficits in developed countries, unfunded liabilities for pensions and entitlements, high unemployment. The list goes on. We equate uncertainty with risk. That's natural, but it is not always correct. In fact, periods of uncertainty can often drive prices of assets so low, that future periods of higher returns are extremely likely.
Inflation Expectations and Portfolio Construction
(Or: Lions and tigers and bears, oh my!)
Early in my career I read something that has always stayed with me: "If you are going to make predictions... predict often." For me, this is an excellent tag line for the mainstream financial media. I take the opposite approach and try to avoid making predictions all together. Don't get me wrong, I will debate with the best of them, but at the end of the day, most of these topics are highly complex and any predictions we make will invariably be wide of the mark. On the other hand, I don't like standing in front of a bus if I can avoid it. So I tend to think of things in probabilities wherever possible (spoken like a true former Engineer).
Which brings me to my current topic: inflation. If you read any of the financial press lately you will undoubtedly stumble on the debate concerning inflation, deflation - and for some of the true rebels out there - stagflation (this reminds me of The Wizard of Oz when Dorothy chants, "Lions and tigers and bears, oh my!"). While any of these are possible in the short term (short term being two to four years), I think the highest probability event in the long term is inflation. I won't bore you with a treatise on inflation, I will just point out two items. One: we are in totally uncharted waters in regards to the enormous size of fiscal stimulus applied around the world. The numbers don't even cause a stir any more unless they start with "T" as in trillion. Two: people. Lots and lots of people. According to the July issue of Fortune magazine, the developed world accounts for 16% of the world's population or 1.1 billion people. The developing world accounts for the other 84%, a staggering 5.8 billion people. Consider this: the US has a population of just over 300 million people. If the developing world moves just 5% of its population from the poorest segment to "middle class" over the next decade that represents an upgrade of 288 million people. Or just about one US population per ten years.
When people move into the middle class, what do they want? I mean... after the latest iPhone? They want a house, a car, better food, air-conditioning, a refrigerator... you get the point. This will put an enormous strain on the resources of the world to provide all the wood, steel and concrete to support the lifestyle upgrade. And along with that comes commodity inflation. As a result, I believe rising commodity prices will be ultimately passed along to the consumer.
So how do we construct our portfolios to account for this? I've outlined the common asset classes that we use and how they are likely to respond to inflation and we'll finish up with a discussion on how they all work together:
This is a simplified example, but I wanted to give you a sense of the different aspects of inflation protection that we can build into your portfolio. If you have additional questions or concerns, don't hesitate to drop me a line or call.
I know that periods of uncertainty can try investor's patience and challenge the discipline to stick with your investment strategy. So don't hesitate to call or reach out if you have any questions or concerns about your accounts or investment strategies
Also, if you have any friends or family who have concerns, please don't hesitate to make an introduction or forward this letter. We provide Financial Planning and Investment Management services and would be happy to talk with your acquaintances. We will treat your friends and family with the same care and diligence that we treat you.
Note: The contents of this site are general in nature and not intended as specific investment advice. All investments are subject to risk; including loss of investment value. If you have any question regarding investments or concepts in these pages, please consult with an investment professional.