Market Commentary

How should you be hedging for inflation?

By Drew Lunt

It appears that the darkest days of the Covid-19 pandemic are behind us. In the last 14 months, the global economy has shown tremendous resiliency, and as we continue to work through a rattled supply chain, businesses begin to reopen.

While companies have been busy trying to keep their doors open, the United States central bank has been busy printing 3 trillion dollars of new money which has dramatically increased the current money supply. 

This money is here, and here to stay.

The fear of the crippling tax, known as inflation, is lurking over our global economy. What can you do as a long-term investor to protect your purchasing power against inflation?

Many investors turn to assets like gold, Treasury Inflation-Protected Securities (TIPS), or equities/stocks to protect their purchasing power.

It is not news to anyone that inflation could ramp up as consumers begin spending money at a higher rate. What investors are now worried about is unexpected inflation. To hedge against this unexpected inflation investors are looking for assets that correlate positively with unexpected inflation, have a positive real return, and reasonable volatility to “hedge” or protect them against inflation.

This asset does not exist.

Gold and other commodities are often looked to in inflationary times as a hedge. The academic literature has found very little correlation between gold prices and unexpected changes to inflation. This combined with Gold’s volatile short-term price movements make it an unreliable inflation hedge. 

TIPS are a compelling asset to own as an inflation hedge given the name. They are indexed to inflation in order to protect investors from a decline in the purchasing power of their money. As inflation rises, TIPS adjust in price to maintain their real value. The principal value of TIPS rises as inflation rises. Inflation is the pace at which prices increase throughout the U.S. economy, as measured by the Consumer Price Index (CPI)*. The image below, from Dimensional Fund Advisors, helps decipher the different components of TIPS vs Nominal Treasury Bonds.

In short, TIPS have been a great hedge against unexpected inflation, but only when your investment horizon matches up perfectly with the bond’s maturity. But this does not eliminate the short-term real return on a long-term protected bond.

We can continue to analyze different assets that provide a correlation to unexpected inflation with positive real returns and low volatility, but there does not seem to be such an investment vehicle.

Historically, equities have provided investors with positive long-term real returns. Ownership in companies has provided a great long-term solution to maintain purchasing power. Intuitively, it makes sense – if you are able to own companies who are selling the same goods and services that are going up, their revenue will likely track with these prices at a minimum.

One of the worst inflationary time periods in the U.S. was the 17 year time period from 1966 -1982. It is known for one of the worst time periods in history to retire. During this time the S&P 500 returned an annualized 6.8%. However, if you just owned the S&P 500 during this time you had a 0% real return after counting inflation.

It is interesting when you look at what happens when you own equities outside of the S&P 500 during times of high inflation. Global diversification (owning companies all around the world) has a compelling story during times of inflation. In the previously mentioned 17 year time period where U.S. stocks earned a 0% real return, a globally diversified portfolio outpaced U.S. inflation. This is a trend that has held during other periods of time with high inflation.

Along with global equity diversification, there are some other compelling equity factors that may provide some sort of inflationary hedge. There has recently been a fair amount of research looking into the performance of value stocks during periods of high inflation. Larry Swedroe, chief research officer at Buckingham Strategic Wealth, recently wrote an article discussing the value premium performance during high inflationary times.

Below is a summary of value premium performance during different levels of inflation.

  • When inflation was between 0 and 3 percent, the value premium was 3.1 percent.
  • When inflation was greater than 3 percent, the value premium was 6.6 percent. When it was below 3 percent, it was 2.4 percent.
  • When inflation was greater than 4 percent, the value premium was 6.2 percent. When it was below 4 percent, it was 3.2 percent.**

There are some limitations when you just look at historical value premium performance. Different influences such as the Federal Reserve’s monetary policy response in times of high inflation can make this data less reliable. However, of the research that has been done, the value premium has shown up in times of high inflation.

Should you be making adjustments to your asset allocation to protect against inflation? Is there an ideal inflation hedge?

It is hard to find any empirical evidence that suggests there is an asset class that can consistently hedge inflation with the goal of positive real returns and low volatility.

Research suggests that overweighting a portfolio towards value stocks and some ex-US exposure may lead to a well-positioned portfolio when periods of high unexpected inflation arise. However, having a diversified portfolio with a long-term approach, surrounded by an evidence-based philosophy, seems to be a good way to weather a variety of storms.

Just remember, it is always the right time to be properly allocated based on your personal goals.


Data resource references:



RW Investment Management, LLC dba R|W Investment Management (“RWIM”) is a Registered Investment Adviser. This document is solely for informational purposes. Advisory services are only offered to clients or prospective clients where RWIM and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by RWIM unless a client service agreement is in place.

March 17th Market Update

We know there is uncertainty, as this is uncharted water for the world. While pandemics are not new, this particular virus strain is new, and as such, we are simultaneously trying to learn and understand while developing a response and treatment.

The uncertainty is being felt around the globe, and it is unsettling on a human level.

Unknowns are unsettling. Lack of understanding can lead to fear, fear can lead to panic and panic can lead to poor decision making and reactionary behaviors. The markets are no more immune to this virus than humanity.

With this in mind, our firm would like to share an internal philosophy that we adopted years ago.  We see our firm as an “ark” providing shelter to our clients to weather the storms. But, what is an ark? If you remember the story of Noah, the ark was a haven that allowed for shelter from the storm. It was a vessel that did not have a rudder or a propeller or even an oar. It was simply a refuge. A place to wait and be safe, while minding the ship.

This is how we view our firm. While we cannot control the pandemic, we will be a refuge while weathering “the storm”. We will mind the ship and provide counsel and services with your best future in mind. We will be a sounding board and a strong shoulder to help bear the load. We will do our best to keep your money working for you.

The thing about storms is that they eventually end. This will end. Just as the ark had to “wait and weather the storm”, so do we. However, when the storms and floods passed, those who emerged from the ark found themselves surrounded by newness and a hopeful promise for a bright future. We will continue to strive to place our clients in the greatest position of strength for a hopeful tomorrow.

In addition, we have attached our current office meeting contingency plan.  Until further notice, we will not be conducting in-person meetings to protect the health and well-being of our employees and clients.

As the day on Monday, March 16th came to a close – we were reminded that storms do pass with a beautiful rainbow over our great city of Boise.

Please call with any questions or concerns.  Stay healthy and strong. This too shall pass.

RW Meeting Contingency Plan - March 2020

March 12th Market Update

This past Monday – March 9 – was the eleventh anniversary of the crescendo of global panic that marked the bottom of the bear market of 2007-09.

It is a thing of the most wonderful irony that the world has elected to celebrate this iconic anniversary with – you guessed it – another epic global panic attack.

The morning of March 9th the opening level of the S&P 500 was 2,764, down over 18% from its all-time high, recorded on February 19. Declines of that magnitude are fairly common occurrences – indeed the average annual drawdown from a peak to a trough since 1980 is close to 14%. But such a decline in barely a month is noteworthy, not for its depth but for its suddenness.

As we all know by now, the precipitants of this decline have been (a) the outbreak of a new strain of virus, the extent of which can’t be predicted, (b) the economic impact of that outbreak, which is equally unknown, and (c) most recently, the onset of a price war in oil. (That last one is surely a problem for everyone involved in the production of oil, but it’s a boon to those of us who consume it.)

The common thread here is unknowability: we simply don’t know where, when or how these phenomena will play out. And in our experience, the thing in this world that markets hate and fear the most is uncertainty. We have no control over the uncertainty; we can and should have perfect control over how we respond to it.

Or, ideally, how we don’t respond. Because the last thing in the world that long-term, goal-focused investors like us do when the whole world is selling is – you guessed it again – sell.  Instead, we encourage you to focus on the sale prices of The Great Companies of America and the World.  They’re enjoying markdowns which we historically don’t see more often than about one year in five, on average

On March 3, the erudite billionaire investor Howard Marks wrote, “It would be a lot to accept that the US business world – and the cash flows it will produce in the future – are worth 13% less today than they were on February 19.” How much more true this observation must be a little over a week later, when they’re down over 20%.

This too shall pass.

February 27th Market Update

Over the last week concerns over the spread of the coronavirus and its potential economic impact have caused global stocks to drop and interest rates to fall.  As of February 27th, the S&P 500 Index has declined approximately 12% from its recent all-time high, causing the financial media to ring the “correction territory” bell.

We do not claim to have any idea how far this outbreak will spread, nor how many lives it will claim, before it is brought under control. We’re reasonably certain that many (or perhaps most) of the world’s leading virologists and epidemiologists are working on it and believe that their efforts will ultimately succeed.  This of course is our opinion.

But if the history of similar outbreaks in this century is any guide, this would seem to be a reasonable hypothesis.

We draw your attention to:

  • SARS in 2003-04, also originating in China
  • The bird flu epidemic in 2005-2006
  • In 2009, a new strain of swine flu
  • The Ebola outbreak in the autumn of 2014
  • The mosquito-borne Zika virus outbreak in 2016-17

On that first day of the litany of epidemics cited above, the S&P 500 closed at 855.70. Seventeen years and six epidemics later (including the current one) the Index is fairly close to three and a half times higher.

Because markets hate uncertainty there has been and will likely continue to be higher volatility in the short-term.  However, it is doubtful that the long-term viability of companies like Exxon and Chevron, or Microsoft and Amazon, or Nestle and Coca-Cola are in danger. Despite the inherent volatility, we believe ownership in companies like those cited provide the best opportunity to protect your purchasing power and grow your families wealth over time.

Our advice is to remain focused on that which remains in our control: asset allocation, diversification, and rebalancing. For our retirees, we have built your fixed income portfolios to provide a minimum of 5 – 7 years of spending without the need to sell stocks. This allows us time to withstand stock market volatility. For accumulators, we will continue to dollar cost average into your diversified portfolios, perhaps accelerating buys as the market drops further.

We believe the coronavirus scare is another example of the market overreacting and therefore a buying opportunity for investors.  Warren Buffett famously said, “Be fearful when others are greedy and greedy when others are fearful.”  You may see activity in your accounts in the days and weeks ahead as we look to take advantage of this opportunity.

FT Cornoavirus Economic Impact