Stocks are a good hedge against inflation because companies can pass along higher raw material, labor and borrowing costs in higher prices and maintain, or even boost, profitability. As inflation rises fixed income security values decline and then interest rates start to rise so fixed income investors can earn a positive, real return (return after inflation). At least that’s economic theory and how prices should work.

Currently we are seeing robust demand for raw materials (copper, iron ore, lumber), Agricultural Commodities (wheat, corn and soybeans) and Energy (oil & gas). Producer prices, the prices manufacturers charge retailers and distributors to make goods for sale to the public, are starting to rise. And indeed, we are already seeing companies in the Consumer Goods areas (Proctor & Gamble, Unilever, Nestle & Coca Cola) announce price increases. Costco, the big consumer household goods retailer has also recently said they plan to pass their higher costs along. And of course, Airlines have already raised fares seeking to earn greater revenues to pay down the debt they had to take on, as are aluminum companies that make cans for Coca Cola and other drink companies. This trend in rising prices has investors quite concerned. Bonds yields have been rising and stock investors fear rising inflation because many think the pent up demand from the Covid-19 pandemic requires less stimulus than the Biden administration and Treasury are advocating.

The central bankers in Europe and our Federal Reserve, believe inflation is temporarily flaring-up only due to the pent up demand over closing down during the pandemic and because parts shortages created short term supply-chain issues. To manifest their belief Fed Chairman Powell has been regularly intervening in the financial markets, buying bonds to repress interest rates and stock futures to steady the equity markets. This Friday’s jobs report seemed to score one for the Fed as unemployment and job creation was lackluster. Millions of Americans are still unemployed, and many make more on unemployment benefits than at their jobs. A handful of GOP states recognize this disincentive to work and are planning to curtail their state’s unemployment benefits because companies have jobs but too many are not applying. It may be the new normal is a greater activist labor force paving the way for union organizers as we are seeing at the Amazon warehouse in Alabama. This is another market risk but for now inflation concerns are the top market worry.

Rising interest rates worry all investors and create competition for equities. We believe the Fed certainly does not want to have to deal with the fallout from a major market correction on top of a recovery, so while the short term volatility and many small cap company valuations present risks, we believe Central banks will continue to intervene with effective monetary policies to maintain spending stimulus and buy bonds to hold interest rate in check. In fact, they almost must because if they don’t debt service will become a bigger problem. Currently with the US owing $30 trillion, a 3.5% normal five-year yield would cost over a TRILLION dollars in interest expense a year. Growth is the answer not austerity.

Nations have been "spending the gap" between what they historically produced in GDP and what they did produce. Trillions have been added to sovereign debt over the past decade and the pandemic has Governments spending more. The probability is that interest rates will be managed to be artificially low for years to come as in Japan. This bodes well for companies and stocks as well as real estate. But of course, there are Got Ya’s. Owning real estate the risk is rising property taxes; with fixed income its loss of purchasing power, and with stocks it’s unsustainable prices. Now is not the time for indexing which offers no risk management. This is a market where managers must use a proven strategy and putting clients on auto-pilot has peril. It’s a time for a Total Compound Return strategy which we pioneered.