Preparing for Higher Prices

I have been thinking about inflation for some time, perhaps too soon from an investment perspective.  However, from the financial markets, there are several items of note on the inflation front.  First of all, the price of oil has risen dramatically in the past few weeks, with spot oil now past $90/pb, a price usually indicating higher prices at the gasoline pump.  In addition, grain prices and other food commodities have been rising as well, usually a sign of an uptick of grocery store prices in the next few months.  And finally, gold and silver, two traditional stores of value when people are concerned with other assets have also had dramatic price increases.  I remain concerned that we may be in for a bout of prolonged inflation for various reasons and have structured my portfolio to include inflation-indexed bonds and non-US$ holdings to try to insulate some of the turn.  However, I also think that this round of inflation will be different than previous.  Note the following with my own take on investment strategies:

–The US resident real estate market is not participating — mostly due to the overhang as well as foreclosures and short-sale homes hitting the market.  In most people’s memory, real estate was the easiest way to participate in an inflation boom, but perhaps not this time.  Given the lack of liquidity in the real estate market, I continue to avoid this sector

–Employment has lagged — there are a number of cyclical and structural elements that are contributing to the slow uptick in hiring by employers.  Unfortunately, this means that a large number of people have not participated in the 89% rise in the S&P500 stock index that has occurred over the past 2 years.  It also means that the current preference for investing in fixed income securities, which are the most vulnerable to inflation, could be misguided.

–Global growth isn’t coming primarily from the US – or even the large countries in Europe.  This round of global growth appears to be led by the large emerging market countries, often called the BRICS (Brazil, Russia, India, China, and South Africa).  If growth continues in this fashion, emerging market stocks and funds should continue to outperform.

–Sentiment lags the market — I believe that this is tied to employment and housing.  With many people worried about job security and underwater with their mortgages, their general sentiment towards the economy may actually lag the real data, especially in certain regions.  I take this as an indicator that a bout of inflation may be surprising to many people and that they may be chasing upmoves in the stock market.

Do some of these trends surprise you? If so, you may need to evaluate your preparedness for inflation.

shared at this week’s Carnival of Personal Finance