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Sterling Thoughts Newsletter
8 Ways to Insulate Yourself from Inflation
by Scot LandborgAs Featured In:
Rising prices are all over the news these days, and they may be with us a while. So, it could be time to take action to protect your investments and limit your costs. Here are eight ideas to consider.
The first half of the year is behind us, with the market performance strong across the board. But what about the rest of the year? With inflation on the minds of many investors, how do you protect against those risks, and what top strategies could help better position portfolios?
Inflation is seemingly everywhere, with the prices of oil, lumber, steel, and real estate all pushing higher. Some of that inflation could be with us for quite some time. Of particular concern is increases in rents – up over 8% nationwide in June to a record high $1,575 per month, according to Realtor.com. Also, rising wages — while good for individuals — can mean higher costs passed on to the consumers.
What can you do to protect yourself from inflation, and how can you ensure your portfolio is keeping up with rising prices?
1.) Don’t Be Too Conservative
Inflationary environments often see asset prices rise, but they can be challenging for the value of bonds. As interest rates rise, the value of your bond portfolio could decrease, potentially eliminating any benefit you are receiving from a consistent yield. In a period of slowly rising interest rates, a traditional bond allocation could mean some dead weight holding back your portfolio from the true upside potential. A portfolio that is too conservative will have a tough time keeping up with inflation.
Conventional financial planning suggests an increasing allocation to bonds as one ages and approaches retirement. For example, if you are 60 years old maybe you need a 35% allocation to bonds. With interest rates so low and inflation becoming more of a threat – you may want to consider decreasing that bond allocation to optimize performance.
2.) Focus on Inflation-Favorable Sectors
Consider increasing your allocation percentages in areas of the market that do well in inflationary environments.
Credit Suisse did research on markets where inflation was expected to increase, and which sections of those markets performed best in those times. They found that on an average day if the S&P 500 was expected to increase by 0.45%, the energy sector was expected to increase 0.86%. Two other areas with the potential to outperform include financials, at 0.68%, and materials, at 0.62%.
Increasing your exposure to funds, ETFs or individual stocks in those sectors could help your portfolio keep pace during an inflationary environment.
3.) Be More Active and Dynamic in Your Risk Management
Increasing your equity exposure could make sense, but it needs to be coupled with a rule set for managing risk. If you use an adviser, ask them about their strategy for managing volatility. If invested in a fund or ETF, look at how that strategy has weathered prior volatile markets and understand what goes into their methodology for risk management.
If you are buying an individual stock or ETF on your own, set your own price targets. Maybe set trailing stop losses to lock in your gains and limit your downside exposure. A trailing stop loss order lets you set a price to exit a stock that rolls up as the stock increases in value. For example, a 15% trailing stop loss on a $100 stock would initiate a sell of the position at $85, but if that stock rises in value to $115 the trailing stop order will ratchet up the exit sale price to $97.75You are getting the stock exposure you want but limiting your downside risk if the market moves the other direction.
The key for any investment strategy is to not rely on emotion and to be levelheaded about your strategy. Take advantage of opportunities in the market but be disciplined in managing your downside exposure.
4.) Consider Technology to Diversify
Technology has been a lagging sector since late last year, but it is emerging again as a place of potential growth. Technology had significant outperformance during the COVID year or 2020 but has had weaker performance since then.
As multiple tech companies recently reported strong earnings, an overweight in your allocation to the sector could be appropriate.
Technology is one of those areas that have the potential to profit during inflationary environments. Tech companies may find it easier to pass price increases on to consumers, and their business models may be less susceptible to pricing and supply chain disruptions.
With the Delta COVID variant surging in many parts of the country, the lower risk of business interruption might also be attractive in technology companies.
5.) Watch the Federal Reserve
One of the biggest concerns about inflationary pressure is what the Federal Reserve might do in response. Actions the Fed could take include slowing its recent bond purchases or raising interest rates. While the members of the Fed have signaled little change to policy in the short term, continued strong inflationary pressure could cause them to change their minds. And that could put the broader market at risk. Action by the Fed to quell inflation could lead to a pullback, requiring that investors take additional risk-management measures.
6.) Adjust Your Expectations
Many investors think about performance on an absolute return basis, but it is important to think about how inflation can impact your financial plans overall. In the short term, does your income need to increase to accommodate the increased costs of goods and services? Does your plan account for inflation, and will your portfolio be able to keep up with rising costs? Now is a good time to re-engage a financial adviser and ask if your plan is aligned with higher inflation expectations. With a 3% annual inflation, like we saw last year, your portfolio needs to do more to keep up.
7.) Reassess Your Long-Term Plans
Housing prices were up 24.8% year over year in June, according to Redfin. If you were considering moving and downsizing, is now the time? The smaller home or community you considered moving to has also likely seen an increase in prices, so beware of potential sticker shock.
Inflation may have a positive impact on your current net worth, as most asset prices have increased. That may give you more flexibility in your plan to reposition or relocate. Just bear in mind that if inflation continues to be an issue, downsizing your real estate might make it more difficult to keep up with inflation as your smaller home may not see as large of an equity increase as a larger home.
8.) Consider Purchase Delays Where Appropriate
The inflation that certain areas of the economy are experiencing will likely be temporary, but for others, it may be longer lasting. You may want to consider delaying purchases of goods or services that are temporarily priced higher due to supply disruption. For example, you might want to delay a home addition because of higher lumber costs, or delay the purchase of a used car as those areas of the market have seen supply chain issues. Similarly, travel to certain areas is in higher demand now, leading to possible price increases. Delay can work as a tactic if you believe price increases in that area are temporary.
In summary, inflation is the biggest story going into the second half of the year. Investors need to be aware of the opportunities and risks of navigating during an inflationary environment.
The third quarter saw a stall in the growth trajectory from the first half of the year. September was the most volatile month of the year as choppiness returned to the markets. The major indexes are off over 5% from their highs but still positive on the year. The S&P 500 is up 14% while the Dow Jones Industrial Average is up 11% and the NASDAQ is up 10% year to date.
At our last Monthly Market Zoom IN*SIGHTS, we discussed if the path ahead could be “slowdown city” or could growth pick up again in a “roaring 20’s” scenario. Our word of caution was that September and October could prove to be a bit volatile. That is what we have seen play out so far.
The political game of chicken with the debt ceiling and the ratcheting up of political pressure around COVID has investors nervous. Also, uncertainty around the Chinese economy and inflation brings more unease. Investor sentiment reached a low not seen since March of last year—at the height of the pandemic. This likely has kept a lid on stocks moving higher. While we remain watchful and vigilant—looking at technical data to track how much of this volatility might be temporary—we remain hopeful for a strong end of the year.
Finally, the Delta variant is rolling over as cases are plummeting nationwide. Hopefully, that means a low COVID winter/spring and a public more able to live with a virus that could be around for a long time to come. Regardless, businesses have been adapting and adjusting to new economic realities and changing business models. The consumer, post Delta, with $17 trillion of cash on deposit for US businesses and individuals could be poised for a spending binge into 2022.
The biggest risk continues to be inflation and the Federal Reserve’s potential responses to it. Inflation below the surface seems significant and longer lasting than the Fed is yet willing to admit. The Fed continues to communicate publicly a willingness to let the economy run hot for some time. There may still be some short-term turbulence in October, but likely, in our opinion, the markets move higher by year-end. We continue to monitor daily and adjust as needed.
Our Sterling Active model has an 85% equity allocation. We shifted this month away from US small cap and took positions in US large cap growth, large cap value, mid cap value and technology. We also have positions in energy and financials—sectors that typically do well in inflationary environments.
The Beacon and Sterling Stop models have approximately 70% equity exposure with a broad and balanced equity allocation.
Flexible Plan MLSGU has had a challenging quarter. While outperforming last year, they are underperforming this year. Much of that is a function of moves to manage volatility in a choppy market environment. Some have been the result of corrections in sectors that Flex Plan was exposed to. Currently, they are invested in the following sectors: semiconductors, biotech, technology, and real estate. We continue to value their risk management and long-term investment strategy.
Sterling Stock Select continues to be our strongest strategy on the year. The strategy is still outperforming. We have added additional individual stock positions and equity index exposure to further diversify the portfolio. To mitigate short term volatility, we have increased our index exposure to 36%. Some of the best performing stocks have been in the energy sector.
We continue to watch the markets closely and are poised to take more protective action if volatility increases. While October may still be a bit bumpy, we are optimistic about the potential for market strength going into 2022. To talk more about your individual portfolio, please email the Service Team at firstname.lastname@example.org or you can call our office at 714-592-7705 and press ext. 2 to schedule an appointment.
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