Concerns about inflation have taken a backseat among investors as they direct their attention toward recession indicators and the forthcoming presidential election. Over the past year, the core Personal Consumption Expenditures (PCE) Index, a primary inflation measure favored by the Federal Reserve, has shown a consistent decline. While this might seem like positive news, it is important to recognize that inflation still persists, albeit at a slower rate of growth. The consequence of inflation is that the cost of goods and services continues to rise, ultimately eroding the purchasing power of dollars.
An examination of the historical data spanning 60 years reveals an upward trend in the Core PCE Index, suggesting that deflationary periods in the United States are rare. Irrespective of the fluctuations in the rate of inflation, it remains an enduring force in the modern economy, gradually diminishing the value of currency over time.
As investors consider methods to preserve their wealth, it is imperative to look beyond the present circumstances. Several factors, including increased spending on decarbonization, the reshoring of manufacturing, higher military expenditure, and labor shortages, may contribute to potential inflationary pressures in the future. Although inflation rates have declined recently, a resurgence is possible.
Three steps are vital to preserving portfolios and retirement savings:
Step 1: Limit excess cash holdings.
Inflation diminishes the purchasing power of cash as time progresses. Therefore, minimizing cash reserves to meet immediate expenses and emergencies is advisable. Relying on considerable amounts of cash as a long-term strategy is an ineffective approach to combat inflation. Alternatively, investing in tangible assets such as real estate, midstream energy companies, or gold can provide a superior defense against inflation.
Step 2: Focus on assets with intrinsic value.
Real estate and gold are commonly regarded as assets that tend to retain their value during inflationary periods. Additionally, midstream energy companies that have made substantial investments in infrastructure could benefit from the increased value of their assets as replacements become more expensive.
Step 3: Seek investments in companies with pricing power.
Corporations that can raise prices without losing market share are better equipped to navigate periods of robust inflation. These companies often have strong brand loyalty, provide essential products or services, or include built-in inflation escalator clauses in their contracts.
A study conducted by Steve Hou, PhD, found that stocks with pricing power consistently outperformed the broader stock market, not only during inflationary periods but also over the longer term. Referred to as “quiet quality compounders,” these companies are known for their ability to generate steady returns while effectively managing inflationary pressures.
A persistent force in the economy, inflation necessitates strategies that protect wealth from its erosion. By minimizing cash holdings, investing in assets that retain value, and selecting companies with pricing power, investors can better shield their wealth against the impact of inflation.