Ignoring The Collateral Damage Of Inflation

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The June inflation numbers are in, and they’re worse than expected.

Inflation surged 9.1% in June, accelerating more than expected to a 40-year high. Economists expected the consumer price index to climb 8.8% in June. This is not good news. The last time inflation was this high was in the 80s; it took two recessions to finally get under control. The implication is that the road ahead could get very rocky, with many pundits talking about recession as if it were already here.

“The first rule of an investment is don’t lose money. And the second rule of an investment is don’t forget the first rule.” -Warren Buffett.

Following Warren Buffett’s advice, one would think that the simplest way to avoid losing money is to put it under the mattress. But, that wouldn’t be wise as you would lose money due to the diminishing buying power brought on by inflation.

Let me illustrate:

If you put $100,000 under the mattress with the intent to buy a $100,000 automobile in a year, because of inflation, that same automobile will cost $109,100 in a year when you go to pull those large bills out from under the mattress to pay for the car. Hiding your money lost you 9.1% in that one year.

So hiding money is not a good idea. But what about common investments? How do they stack up against inflation?

Here’s a summary:

  • Stocks. Stocks have historically moved in the opposite direction of inflation. This is due to the Fed’s approach to corralling inflation and increasing interest rates to slow business and consumer spending. Decreased spending hits corporate bottom lines, which lower stock prices. This year, as the Fed has increased interest rates three times, the Dow has shed more than 14% in the same timeframe.
  • Money Market Accounts (MMA’s). The best rate listed by Nerdwallet for MMA’s is 1.10%. That’s an annual loss of -8.0% when considering inflation.
  • High-Yield Savings Accounts (HYSA’s). The best rate listed by Nerdwallet for HYSA’s is 1.52%. That’s an annual loss of -7.58% when considering inflation.
  • Annuities. Some of the best fixed-income annuity rates right now hover in the 4.5% range, but that doesn’t take into account administration fees of 1-3% annually, putting real rates at 1.5% to 3.5%. In the best-case scenario, the annual loss of the best annuity is -5.6% when considering inflation.
  • Treasuries. The current 10-year treasury rate sits at 2.96%. Considering inflation, that’s an annual loss of -6.41%.

 
The Investing Landscape

A survey of the investing landscape does not paint a pretty picture for investors. Traditional investments and new “cutting edge” investments are not doing well in the face of inflation, but that doesn’t mean all investment has stalled. Not all investors are hiding or parking their cash in money-losing assets. One class of investors is actively shopping for opportunities.

The ultra-wealthy are prepared for any economic environment, and inflation doesn’t stop them from shopping. But, what are they shopping for?

Surprisingly, they’re not shopping for anything different than what they usually shop for. They’re just looking for bargains in this environment, as evidenced by the record amount of dry powder (cash on hand for acquisitions) reported recently by investors anticipating a downturn and looking to pick up bargains. But, what kind of assets are they pursuing?

The ultra-wealthy are pursuing assets that will bulletproof their portfolio from the twin terrors of inflation and recession. What are they allocating to?

Cash flowing tangible assets tied to essential goods and services – non-luxury items that consumers will always need like shelter. That’s why certain classes of commercial real estate (CRE) like affordable housing that thrive in downturns are a big draw for these investors.

Case in point:

While single-family housing values plummeted during the Great Recession, the affordable housing sector thrived, including affordable multi-family and mobile home communities (MHCs).

MHCs demonstrated their resiliency again during the pandemic-induced downturn, where MHCs saw occupancies and rents increase compared to other asset classes. That resiliency has persisted where demand remains high even in the shadow of inflation. While some CRE sectors are cyclical, with some sectors like retail and office more correlated to the broader economy, MHCs have proven to be less correlated and thrive during downturns.

One way to ignore the collateral damage of inflation and thrive in this environment is to allocate away from assets in the path of inflation’s destruction towards assets that generate returns that either keep pace with or even exceed inflation.

Essential assets like MHC have proven that operators can increase rents consistent with inflation without any reductions in occupancy. If there’s one asset built to bulletproof your portfolio from inflation, this is it.

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