Investing for Inflation in 2010

I had written about investing for inflation in a series of posts a little over a year ago.  At the time, stock markets were near their nadir and there was talk of massive inflation due to aggressive monetary policy action.  Over the next couple of months, I made some tweaks to my asset allocation to reflect a greater risk of inflation.  Interestingly, since that time, interest rates have stayed low and are likely to stay low longer than expected, the employment picture has not improved, and the general talk is of the risks of deflation.  With the talk of deflation, I will once again look to tweak my portfolio to make sure I am adequately set up for a surprise in inflation.  However, I think this cycle will not follow traditional inflationary expansions.  These are the asset areas I am examining:

–Emerging market stocks (and bonds) – unlike previous cycles, I think the inflationary push will come from global growth, primarily emerging markets.  The greatest contributor to global growth in the past couple of years has been China, not the US or Europe.  I still remain long-term very bullish on these markets, with caveats for valuation concerns.  These are of course some of the highest volatility asset classes, so I have to prepare myself for big ups and downs.

–Commodities and commodity stocks – the global growth story has helped commodity-related investments do very well in the last several months.  As long as global growth doesn’t have a large shock to the system, commodities are likely to outperform.  I am playing this through ETFs related to metals and mining, as well as commodity-linked currencies such as the Aussie dollar.  One area that I am studying further is agriculture related ETFs.

–Real Estate — I have been generally pessimistic about real estate markets in the US since the real estate overhang stil seems to be present.  Although bargains may be available, I think this market will be impaired by liquidity concerns.  This is one of the major differences from previous inflationary cycles.  I am examining various REITs including international REITs since many were beaten down in the past couple of years.  This is more of a valuation play rather than a macro call.

–Bonds, TIPS, and other fixed income — interestingly, corporate bonds have performed really well as risk premiums have declined.  TIPS (inflation-indexed bonds) have underperformed.  At present with bond yields very low, the risk is that they move sharply higher.  For now, I am very cautious about bonds.

shared at this week’s Carnival of Personal Finance