Our Take on Inflation
It's worth what reviewing what rising prices might mean for stock investors.
Inflation may be subdued today, but the debate over inflation is anything but tame. Pessimists, such as hedge-fund manager Julian Robertson, of Tiger Management, say rampant inflation is a looming threat. “I ask anyone to give me an example of an economy beefed up by huge amounts of fiscal and monetary stimulus that did not inflate tremendously when the economy improved,” he recently told us.
Optimists like David Herro, co-manager of Oakmark International fund, disagree. “The global economy is soft, and there’s excess capacity, so I believe inflation is still preventable,” says Herro.
Gold advocates. The debate over gold, considered an excellent inflation hedge by some, is equally lively. Top investors, such as Paulson & Co.’s John Paulson and Greenlight Capital’s David Einhorn, placed big bets on gold in 2009. Einhorn explained his rationale at the recent Value Investing Congress: “Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Prospectively, gold should do fine unless our leaders implement much greater fiscal and monetary restraint than appears likely.”
![https://cdn.mos.cms.futurecdn.net/hwgJ7osrMtUWhk5koeVme7-200-80.png](https://cdn.mos.cms.futurecdn.net/hwgJ7osrMtUWhk5koeVme7-320-80.png)
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
At the same conference, Bill Ackman, of Pershing Square Capital Management, said he avoids gold because it is “a greater-fool investment.” In other words, making money on the yellow metal is less a function of a rise in its fundamental value and more a function of finding someone who is willing to pay you more for it. Tiger’s Robertson describes his aversion to gold similarly: “It’s less a supply-demand situation and more a psychological one -- better a psychiatrist to invest in gold than me.”
Because inflation hasn’t afflicted America in some 30 years, it’s worth reviewing what rising prices might mean for stock investors. In a 1977 article on the subject in Fortune, Warren Buffett went to great lengths to disabuse shareholders of the notion that they could skate through inflationary times unscathed. He wrote that companies have little ability to improve returns on capital when inflation is high, so investors aren’t willing to pay as much for each dollar of corporate earnings. The subpar, 5.2% annualized return for Standard & Poor’s 500-stock index from 1973 through the end of 1981, a span during which inflation rates often hit double digits, provides ample support for that argument (adjusted for inflation, stock returns were negative).
We’d love for policymakers to successfully reignite the U.S. economy without also rekindling inflation. However, the more prudent course is to assume that all won’t go smoothly.
What do we recommend? We respect many of those who advocate gold, but, like Ackman and Robertson, we believe it’s too difficult to assign a value to the metal. Instead, we prefer high-quality companies with significant foreign exposure and the ability to raise prices. Both Microsoft (symbol MSFT) and Pfizer (PFE) recently reported better-than-expected earnings that signal the resiliency of each company’s business. In Microsoft’s case, those results don’t yet reflect the launch of its Windows 7 operating system, which we think will result in much better profits than analysts expect.
You can also hedge against rising inflation by investing in businesses tied to natural resources, from crude oil to agricultural commodities. One favorite in this category is Contango Oil & Gas (MCF), which explores for energy mostly in the Gulf of Mexico.
More-adventurous investors who believe that higher inflation will lead to higher interest rates can bet against long-term U.S. Treasury securities through options and various exchange-traded funds (bond prices generally fall when rates rise). For example, we’ve shorted iShares Barclays 20+ Year Treasury Bond ETF (TLT), which is designed to gain value when yields fall and Treasury-bond prices rise. If inflation rises rapidly and rates follow suit, Treasury bonds will perform poorly.
Columnists Whitney Tilson and John Heins co-edit Value Investor Insight and SuperInvestor Insight. Funds co-managed by Tilson own shares of the stocks mentioned above.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
-
Stock Market Today: Dow Outperforms After IBM Earnings
Investors also parsed a strong reading on second-quarter GDP and a dismal decline in durable goods.
By Karee Venema Published
-
Try the 6 to 1 Grocery Shopping Method to Save Time and Money
The 6 to 1 Grocery Method can help you save money, reduce waste and eat healthier.
By Erin Bendig Published
-
Stock Market Today: Dow Outperforms After IBM Earnings
Investors also parsed a strong reading on second-quarter GDP and a dismal decline in durable goods.
By Karee Venema Published
-
Stock Market Today: Stocks Tumble on Disappointing Big Tech Earnings
Poorly received quarterly results from Alphabet and Tesla sparked a steep selloff in equities.
By Dan Burrows Last updated
-
Stock Market Today: Mega-Cap Tech Rallies to Drag Markets Higher
Markets focused on upcoming earnings from Magnificent 7 stocks rather than chaos in D.C.
By Dan Burrows Published
-
Stock Market Today: Stocks Tumble After Spectacular Global Internet Crash
Market participants rushed out of risk assets to end a wild week of trading.
By Dan Burrows Published
-
Stock Market Today: Dow Sinks 533 Points as Big Banks, Mega Caps Slump
Goldman Sachs and Apple were two of the worst-performing blue chip stocks on Thursday.
By Karee Venema Published
-
Stock Market Today: Semis Get Slammed and Blue Chips Bounce
The potential for more curbs on tech sales to China set off a rotation into blue chips.
By Dan Burrows Published
-
Stock Market Today: Dow Spikes 742 Points After UnitedHealth Earnings
The S&P 500 and Nasdaq also scored wins Tuesday albeit with much smaller gains than the blue chip Dow.
By Karee Venema Published
-
Stock Market Today: Dow Adds 210 Points as Apple, Goldman Hit New Highs
A big rally in blue chips and some dovish Fed speak boosted the equities market Monday.
By Karee Venema Published