Many economists have been concerned, they say, with deflation over the past decade but for a variety of reasons, inflation might become more of a concern, particularly under the current US administration. What should investors do?
The following article is by Yuen Yung. Yuen Yung is chief executive of Casoro Capital, a private equity firm which creates discretionary funds for investing in multifamily properties and developments. (There is more detail on the author below.) The editors of Family Wealth Report are pleased to share these insights and invite readers to respond. Email the editor at firstname.lastname@example.org
As President Trump settles into the White House, the market is looking decidedly unsettled. But that's to be expected. The new head of the executive branch of the US government was very vocal about shaking things up while campaigning for office — and it's quickly becoming obvious he wasn't all talk.
Trump has lost no time in making good on promises to reduce financial regulations and tighten immigration policies; it stands to reason that rolling out his plan to pump $1 trillion into the U.S. economy toward infrastructure spending isn't far behind. When large sums of money are introduced into the economy, historically inflation has followed, causing many financial analysts to warn against "Trumpflation" ahead.
Depending on who you ask, Trumpflation will either be a blip on the radar or a devastating M8 on the Richter scale. And the camp claiming Trumpflation — or even just Trump in the White House - will mean "a global recession with no end in sight" is speaking loudly enough to make anyone's client base nervous.
But those of us in the financial advising industry know that there are very few times when the sky is actually falling. Proven methods exist for mitigating risk, and the market has a way of righting itself and rewarding those who don't panic.
To hedge against inflation, financial advisors may consider recommending that clients invest in things like commodities, income generating real estate such as multifamily housing or rental property, life settlements, newer company ventures with revenue components, and private lending opportunities.
These arenas are attractive during times of inflation because they're not related to the stock or bond markets, and are therefore unaffected by them. Also, in the case of commodities and real estate, the investments require that capital or investment dollars be put into something tangible, meaning the cash is converted into a commodity likely to gain value, rather than remaining liquid and therefore more vulnerable to inflation.
Real estate and commodities in particular have a track record of performing well during times of inflation. According to research conducted by Wiley-published author Craig Israelsen, Ph.D., from 1970 to 2015 the U.S. experienced twenty-three cumulative years with inflation rates above the median inflation rate of 3.29 percent. During the years that inflation rose above 3.29 per cent, the average real return for commodities was a 15 per cent gain. The next closest performer was real estate with an average real return of a 6.7 per cent gain. Conversely, the average real returns during the same time frames for large US stock, small US stock, US bonds, and US cash were 4.4 per cent, 60 per cent, 2.9 per cent, and 1.3 per cent, respectively.
An added bonus for real estate and commodities - and one that might not be immediately apparent - is that they can be highly effective in a negative correlation strategy. Over the 50-year period from 1962 to 2012, the average stock-commodity correlation was 0.13, and the average bond-commodity correlation was -0.09. For the period of 2001 to 2010, stock-real estate correlation was 0.23 and bond-real estate was -0.17. So making a full about-face in strategy isn't necessary to benefit from their durability in times of inflation. Just purchasing commodities and real estate for a portfolio primarily composed of stocks and bonds will ultimately help it weather inflation due to the negative correlation between the pairs of asset classes.
The benefit of a negative correlation strategy during a volatile market lies in the near zero-sum results. If implemented correctly, there is a reduced risk of loss (as well as a reduced chance of gains) as the negatively correlating investments inversely rise and fall in value. During economic uncertainty, a negative correlation strategy can be very attractive to more cautious investors, or for those nearing retirement. It's a safe place to wait out the storm, so to speak. At least until the market returns to normal, when you can advise your clients to switch to a strategy that offers more growth potential.
As your client's financial advisor, you're the ultimate expert on the right strategy for mitigating their individual risk of Trumpflation - and the person with the best chance of drowning out the Chicken Littles trying to scare the bejesus out of them. It's my hope that the strategies I've outlined will provide fodder for your ongoing conversation with clients as they navigate the waters of the current volatile market and look to you for education and guidance.
About the author:
Building on the expertise of The PPA Group, a renowned commercial investment and servicing corporation, Casoro Capital, of which the author is CEO, uses local market knowledge and vertically integrated financial and operational expertise to enhance value for investors and residents. Casoro Capital, partnership with The PPA Group, have achieved over $600 million in multi-family transactions. Yuen holds a Bachelor of Business Administration from the McCombs School of Business at The University of Texas at Austin. He is also a graduate of MIT’s Entrepreneurship Masters Program and has professional certifications as a Chartered Mutual Fund Counselor and Board Certified Financial Planner.