Inflation. 

The feeling you get after eating Cinnabon.

Also, a word that refers to the general increase in prices. 

Inflation is said to occur when a dollar today purchases less than what it used to be able to purchase.

The annual inflation rate in the US accelerated to 8.3% in April of 2022, nearing the highest level in 40 years.

So, the question that suggests itself in this environment is:

Where should investors put their money when inflation is high?

We’ll examine some of the most popular options in this article.

1. Cash

Cash is a tough position to hold considering the definition of inflation is that cash is losing its purchasing power. We mentioned earlier, as of April 2022, cash lost 8.3% of its purchasing power in the U.S. in the last 12 months.

Mind you this is a lot better than many other places in the world. 

Turkey reportedly registered an annual inflation rate of nearly 70% during this same period. 

That said, Turkey had an extreme experience with inflation during this period. Inflation tends to be less than 10% annually for most developing and developed countries. 

So, while not exactly offering the most attractive returns, cash holders in most currencies around the world did a lot better than say ARK Invest holders in the last 12 months who are down close to 60%.

So, cash isn’t necessarily a horrible option even in times of inflation. It all depends on the alternatives that are available to you. 

There is also a type of cash-generated return that is often overlooked which comes from peace of mind. 

When the sky is seemingly falling, having enough cash to cover your expenses for the next 6 months will work wonders on your state of mind and stress levels.

A peaceful state of mind will pay cascading dividends that impact your general health, and mental clarity, which ultimately impacts the quality of your decision-making, including your investment decisions which yield actual monetary returns.

2. Stocks

Stocks are a mixed bag in periods of high inflation. To the extent a company can raise the prices of its goods and services, the company’s revenue will rise as it raises prices, but its expenses will likely rise too. The question is whether the rise in revenue outpaces the rise in costs or the opposite.

This largely depends on how much pricing power the company has. Many companies, especially those selling non-essential items, won’t be able to raise their prices without destroying demand for their product.

If a restaurant starts raising its prices, for example, its would-be patrons may decide to eat at home instead. Additionally, inflation tends to come with higher interest rates as we are seeing. 

As lending becomes more attractive, more investors will pull their money out of stocks and into lending products such as bonds which causes a general reduction in stock prices.

So which stocks perform the best during periods of high inflation?

Three words for you: Stationary. Bike. Manufacturers.

I’m kidding.

The answer is actually one word: Oil.

Oil-related stocks tend to perform the best during periods of high inflation. 

That said, if you’ve invested heavily in oil, you have to time getting out exactly right. This is because generally speaking commodities like Oil tend to trend lower with time not higher. 

Generally speaking, inflationary environments are where commodities tend to shine, and then they pretty much stink the rest of the time.

What does inflation do to S&P 500 stocks and others? 

According to a recent Wells Fargo Report “Small stocks top large ones. And S&P 500 growth stocks outperform value. This is a bit counterintuitive as energy sector stocks are typically included in value indexes and ETFs. And yet S&P 500 value stocks rose just 8% during inflationary periods. That’s nearly half the 12% gain by growth stocks.”

“And if growth is good, small stocks are even better. U.S. small-cap stocks rose 15% during inflationary times since 2000.”

Regardless of anything, whether you’re considering value or growth stocks, you want to make sure the companies you invest in have enough cash on hand. You don’t want a company that needs to raise money to fund its operations in this type of environment because they either won’t be able to find it or if they do it’s going to be expensive and eat into their profits substantially.

3. Real Estate

Real Estate tends to do better in inflationary environments than stocks and cash. House prices and rent rates tend to rise with inflation, although rising interest rates can put a damper on how much houses rise since the more expensive it becomes to borrow, the less willing and able buyers there will be in the market.

“According to a 43-year review of the NCREIF Property Index, private real estate total returns were robust during years of inflation. A recent example is the 12 months ending in Q3 2021, when annual real GDP growth and inflation rates were 4.9% and 5.4%, respectively, but the NCREIF Property Index posted a healthy annual rate of 12.1%.”

The challenge with investing in Real Estate as a Muslim is finding a truly halal source of financing. Without financing, investing in real estate is much more difficult from a feasibility perspective. Even if you are able to invest, without any financing, your returns are going to be much more modest.

4. Gold

Gold investors often view it as a way to hedge against inflation risk.

The truth is, based on historical data, Gold’s returns have had very little connection to inflation.

“For example, gold investors lost 10% on average from 1980 to 1984, when the annual inflation rate was about 6.5%, according to Arnott’s analysis. The Federal Reserve tries to keep inflation around 2% per year. Similarly, Gold yielded a negative 7.6% return from 1988 to 1991, a period when inflation was about 4.6%. However, investors won big from 1973 to 1979, when the annual inflation rate averaged 8.8%. Gold returned a whopping 35%.”

So, if you think Gold will necessarily protect you against inflation, historical data suggests otherwise. 

That said, while it isn’t necessarily protection against inflation, Gold is a good source of diversification since it sort of has a mind of its own.

5. Bitcoin and cryptocurrencies 

Since Bitcoin (BTC) emerged in 2009, it has greatly outperformed all other asset classes. From 2011 to 2021, the average annual return was 230%. This is ten times higher than the NASDAQ 100, the second-best performing asset class of the decade.

In terms of protecting against inflation, even though proponents claim that it does, we can’t say it fills this role yet since so far Bitcoin performs like a high-risk technology stock. This makes sense since it is an emerging technology that largely attracts technology investors.

That said if you think Bitcoin has a good long-term investment thesis, as I do, and you have a long-term investment horizon, then buying when the Bitcoin price dips seem like a prudent idea.

The same applies to any other cryptocurrency project you may be considering. Just know that if Bitcoin as an investment seems to have the risk profile of a high-risk technology stock, any other altcoin is should be viewed as a super-duper high-risk technology stock.

Hope this helped. If you’d like to follow the investment moves of yours truly, consider becoming a PIF member.

References:

  1. 10 Year Inflation Chart https://tradingeconomics.com/united-states/inflation-cpi#:~:text=Inflation%20Rate%20in%20the%20United,percent%20in%20June%20of%201921
  2. Turkey Annual Inflation https://www.marketwatch.com/story/turkeys-annual-inflation-rate-now-running-at-nearly-70-01652206687
  3. Country-wise inflation rate https://tradingeconomics.com/country-list/inflation-rate
  1. ARK Invest Returns https://g.co/finance/ARKK:NYSEARCA?window=1Y
  1. US Oil ETF https://g.co/finance/USO:NYSEARCA
  1. Oil as an investment during inflation https://www.investors.com/etfs-and-funds/sectors/sp500-wells-fargo-heres-the-best-asset-to-own-during-inflation
  2. Rising Interest Rate and Inflation https://www.forbes.com/sites/forbesbusinesscouncil/2022/02/24/how-rising-interest-rates-and-inflation-impact-real-estate-investments/?sh=701d4171601f
  3. Inflation Hedge History https://www.cnbc.com/2021/06/08/gold-as-an-inflation-hedge-history-suggests-otherwise.html
  4. Blockchain Price History https://investingnews.com/daily/tech-investing/blockchain-investing/bitcoin-price-history/

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