Consumer Price Inflation has Spooked Investors Everywhere

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What not to do with your money now…

It has been the worst June in 77 years, says Bloomberg. In June of 1930, the Dow lost 18%. So far, it is down 9.4% this month. Since this is the last day of the month, we presume that is where it will stay.

The rest of the news is not much better. Oil closed over $140 a barrel on Friday. OPEC’s president says it could go to $170 by the end of the year.

And the New York Times says the number of people who can’t pay their mortgages continues to grow. There were 2.6 million of them six months ago. Now, the figure has risen to 3 million.

The combination of ’30s-style asset deflation and ’70s-style consumer price inflation has spooked investors everywhere.

“Falling prices grip stock markets around the world,” reports the Financial Times.

Where can you turn for relief, the paper asks? “Nowhere,” is the answer it gives.

Nowhere?

All the world’s stock markets have taken losses, most of them bigger losses than those on Wall Street. Property prices, too, are headed down in most places. So, don’t bother to diversify. It barely matters where you look – asset prices are sinking.

“Diversification no longer works,” writes Tony Jackson in the Financial Times. Mr. Jackson says rising inflation rates are playing hell with all sorts of investments. Bonds, equities, real estate – anything that produces a fairly steady stream of income – is vulnerable, because the money you receive, whether as dividends, rent or interest, becomes less and less valuable. Result: big drop in assets prices.

So, how do you protect yourself? You already know the answer, dear reader. But let’s look at the possibilities to make sure we haven’t missed something.

Let’s begin with real estate. Over the long run, property usually stays even with inflation. But the trouble now is that this bout with inflation begins when property prices are already high…and coming down. Real estate prices are adjusting downward after a record bull market. Inflation just makes the correction worse, since wherever prices end up in nominal terms, they’ll be even lower in real terms.

The same could be said of stocks, but with slightly less conviction. U.S. stocks fell heavily last week. But they’re still down less than 15% from their all-time high. You could even argue that they’re cheap; that is, if you take current super-low bond yields into account. But as inflation rates go up, so do bond yields – normally. Then, stocks go down with bond prices. Why? Because when bond prices go down, yields go up, making bonds more attractive than stocks.

Of course, not all stocks will do badly. If we are replaying the ’70s, we’ll find that oil stocks provide a return above inflation. Gold stocks too could produce spectacular rates of return for a few years. But most stocks will probably go down.

Bonds are always vulnerable to inflation. Remember the ‘bond vigilantes’? These were the guys who dumped bonds as soon as they caught a whiff of higher inflation in the air. These fellows went to sleep during the Reagan Era. Paul Volcker had inflation under control; bonds were in a long-term bull market; the vigilantes had nothing to do. Once in the land of nod, they stayed asleep for the next 20 years. Only recently have they begun to stretch and yawn.

But real yields are still so low; the vigilantes still have not completely wiped the sleep from their eyes. In the United States, for example, the real yield on a 10-year T-Note is MINUS 2%. And last week, the yield on the 10-year T-note fell below 4%. We don’t know what to make of it. But as inflation increases, that yield is going to rise – meaning, the value of bonds will go down.

No, dear reader, bonds are no country for old men, at least not for old men with money. Not when inflation is going up.

How about treasury bonds linked to inflation, or TIPS as they are called? Nope. Don’t even think about it. For one thing, when the bond market goes down, inflation-adjusted bonds go down too. Because there are two parts to the value of these bonds – there’s the regular part, which acts like any other bond, and there’s the inflation-adjusted part, designed to offset the loss from inflation. The inflation- adjustment only offsets inflation, not the loss from the bond market.

And even the inflation-adjustment is no sure thing. The people who decide how much inflation compensation you get are the same people who have to pay you for it. It is a bit like letting the undertakers decide when you are ready to die; the conflict of interest may be good for their business, but it might be bad for you. What is good from the government’s point of view is a low official inflation number. Billions and billions of dollars depend on the CPI calculation- everything from tax rate adjustments, Social Security payments, to monetary and fiscal policies. In a better world, perhaps we would have honest inflation numbers. But in a better world, we wouldn’t need them.

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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Comments

  1. “Diversification no longer works,” writes Tony Jackson in the Financial Times…Result: big drop in assets prices.”

    Why are you quoting this idiot? Diversification is not about the return on investment because that component no one can ever be sure of ex-ante – it will affect returns but only as an indirect influence through the adjustment of portfolio volatility. Diversifying one’s portfolio is about minimizing risk exposure so that your investment outperforms, on average, a designated index over time. When markets recede, and in the case of globalization everybody tumbles, your portfolio is also sure to take a hit.

    If your capital was focused towards an industry which weathered the collapse, then good for you. If however you threw all of your weight into a real stinker of a sector, like financials, then stiff cheddar. Diversification alleviates this extremity because it cushions the impact of a bearish trend by mitigating the underlying volatility, ie. removing unsystematic (specific) risk.

    Like hedging, the downside is a sacrifice of potentially stellar returns for relative peace of mind. It’s the layman’s choice and it certainly won’t make you rich overnight. Alternatively, putting all your eggs in the one basket and watching it with unswerving viligance will magnify your upside but it could also leave you pantsless if you fail to identify and act before a critical turning point in the market. Those whom are daring enough to engage in these gambles are only confidence because, most of the time, they have some form of informational advantage over the market.

    This Jackson clown and his misleading commentary is just one why publications such as the FT and WSJ aren’t worth the paper they’re printed on. And to think they charge people to read their crap.

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  2. Bill: the mystery is why, this time round, your “Fed punishers” have chosen to use oil, but not US treasury bonds to fight the US Govt’s rubbery inflation rate and phoney low cash rate. Why aren’t the Chinese and Japanese, big holders of US bonds, playing the game and offloading their stash? There’d be a lot less collateral damage for the rest of the world if US bond prices nosedived instead of oil prices going through the roof.

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  3. The USD is the world’s reserve currency. China,Japan, the UAE, Russia and India are all long USD in their foreign reserve accounts. The implications of any one of these major entities undertaking a drastic short position on the USD would be immense. The value of the greenback would certainly be subject to free fall we’ve yet to experience.

    If such an unprecendented move occurs with even one of those major palyers then (1) the remaining holders of USD would be pretty vexed about their worthless pile of Benjamin Franklins and (2) a significantly depreciated USD would devastate exporters who, despite its recent lacklustre, still depend on the States for sustaining global demand given the lack of a befitting alternative.

    Furthermore, it would be pretty hard not to attract attention when you’re trying to dispose many billions of USD in several large transactions (just imagine China with its aproximately USD 1.87 Trillion reserves). It will be utter pandemonium.

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