Author Topic: Stocks are NOT an inflation hedge  (Read 3680 times)

vand

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Stocks are NOT an inflation hedge
« on: June 05, 2019, 04:58:50 AM »
The argument I hear from stock  permabulls goes "stocks have the best long term return, so they stand the best chance of beating inflation in the long term."

This is true. It is also nonsense.

See here: https://www.aaii.com/journal/article/asset-returns-during-high-and-low-inflationary-periods



Stocks have historically underperformed during periods of higher inflation. In fact, their average real return is less than half what is is during periods of lower inflation.

It is commodities and hard assets (inc real estate) that are the really effective hedge during inflationary periods.

So if you are really worried about inflation, it makes more sense to balance your portfolio with a component of commodities rather than relying on long term stock returns to outstrip the inflation.

Revision 06/06:
commodities are the only asset class that clearly thrive and prefer higher inflation. Real Estate and Small caps while doing fine during still do relatively better during low inflation periods, so while it may still be acceptable to hold RE/SC and come out ahead, the do not exhibit hedging characteristics.

« Last Edit: June 06, 2019, 02:32:12 AM by vand »

wageslave23

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Re: Stocks are NOT an inflation hedge
« Reply #1 on: June 05, 2019, 09:36:52 AM »
Its still a hedge against inflation because the real returns are still positive above inflation.

PDXTabs

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Re: Stocks are NOT an inflation hedge
« Reply #2 on: June 05, 2019, 09:57:34 AM »
Its still a hedge against inflation because the real returns are still positive above inflation.

☝️

EDITed to add: and even if real returns were negative it would still be an inflation hedge if they were only a little bit negative and better than other asset classes.
« Last Edit: June 05, 2019, 10:13:12 AM by PDXTabs »

Laserjet3051

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Re: Stocks are NOT an inflation hedge
« Reply #3 on: June 05, 2019, 11:08:09 AM »
The chart (data) you posted argues AGAINST your point, which I vehemently disagree with. Though, will admit, that short of TIPS, nothing is "guaranteed" to withstand inflationary pressure.

BicycleB

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Re: Stocks are NOT an inflation hedge
« Reply #4 on: June 05, 2019, 11:23:41 AM »
Very interesting article!

Portfoliocharts.com uses similar data. I put the portfolio in there; results displayed were similar to the article's chart. Unusually low volatility compared to portfolios without the commodity and real estate components, yet similar long term returns (slightly better).

Still, the article makes the assertion "Inflation will return." It hasn't ever left most countries, so I interpret this to mean "inflation is going to go up." Do we know that's true?

After all, the high-inflation years in the data were mostly from the era of switching to fiat currency. We already did that. Inflation's been going down ever since, globally on average and within the US, the dominant currency issuer. Economists are vigorously arguing as we speak about whether inflation will ever return. As investors, should we make the same assumption of returning inflation that the article does?

Tyler

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Re: Stocks are NOT an inflation hedge
« Reply #5 on: June 05, 2019, 11:38:10 AM »
Its still a hedge against inflation because the real returns are still positive above inflation.

Just because the average return of A is higher than the average downside of B speaks nothing to whether A is an effective hedge against B.  That requires information about correlations.  Did A come through when B needed it most?

Think of it this way.  Would you consider an asset that repeatedly experienced a negative inflation-adjusted CAGR for more than a decade at a time to be an effective inflation hedge?  It's not to say stocks aren't an important part of long-term portfolio growth, but more diverse portfolios can have consistent positive real returns in short-term and mid-term inflationary environments as well.

As an aside, I have a ton of respect for Craig Israelsen -- the author of the linked article in the OP.  He knows his stuff, and if you want to see how his ideas work in practice he's also the author of the 7Twelve Portfolio.  Compare the heat map (which displays the real returns) to the same for the Total Stock Market portfolio, and you'll get a good feel for his larger point about how diversification helps protect a portfolio against inflation.
« Last Edit: June 05, 2019, 12:24:55 PM by Tyler »

bacchi

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Re: Stocks are NOT an inflation hedge
« Reply #6 on: June 05, 2019, 11:46:37 AM »
Interestingly, inflation doesn't seem to be a drag on stock prices in other countries. As Tyler suggested, there may be a correlation/causation problem here.

There are various studies examining a lag on stock prices due to inflation. I've posted some before but this is another one:

https://www.jstor.org/stable/3594994?origin=crossref&seq=1#page_scan_tab_contents

Tyson

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Re: Stocks are NOT an inflation hedge
« Reply #7 on: June 05, 2019, 11:49:08 AM »
We know that long term real stock returns with dividends reinvested is 10%

We know that long term inflation rates are 3.2%

Ergo, over the long haul, stocks give aprox. 7% returns with inflation factored in.

In the short term, inflation may rise more than stocks, and vice versa.  But hopefully nobody HERE is making investment decisions based on short term fluctuations. 

wageslave23

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Re: Stocks are NOT an inflation hedge
« Reply #8 on: June 05, 2019, 02:24:44 PM »
Its still a hedge against inflation because the real returns are still positive above inflation.

Just because the average return of A is higher than the average downside of B speaks nothing to whether A is an effective hedge against B.  That requires information about correlations.  Did A come through when B needed it most?

Think of it this way.  Would you consider an asset that repeatedly experienced a negative inflation-adjusted CAGR for more than a decade at a time to be an effective inflation hedge?  It's not to say stocks aren't an important part of long-term portfolio growth, but more diverse portfolios can have consistent positive real returns in short-term and mid-term inflationary environments as well.

As an aside, I have a ton of respect for Craig Israelsen -- the author of the linked article in the OP.  He knows his stuff, and if you want to see how his ideas work in practice he's also the author of the 7Twelve Portfolio.  Compare the heat map (which displays the real returns) to the same for the Total Stock Market portfolio, and you'll get a good feel for his larger point about how diversification helps protect a portfolio against inflation.

True, but the chart posted as evidence that it's not a hedge against inflation is not evidence supporting that conclusion.

ChpBstrd

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Re: Stocks are NOT an inflation hedge
« Reply #9 on: June 05, 2019, 03:00:07 PM »
The inflation of the 1970s was a situation where political pressure on the federal reserve to keep rates low, and the federal reserve’s acquiescence, led to a spiral of inflationary expectations and a generation of political leaders unwilling to take the fall as Reagan and Volker eventually had to. I see the same situation unfolding with Trump’s very public pressure campaign to lower rates. Also, the trade wars will have an effect similar to the OPEC embargo - driving up costs across most supply chains and reducing the flow of dollars into foreign bank accounts where they do not contribute as much to monetary velocity within the U.S.

The tricky part is there was about a 40% correction in the early 70’s. Hell of a time to be “hedged” in long stock positions. It’s also no fun to own bonds during times of economic distress or rising rates.

As for me, I own 95% stocks tightly hedged with protective put options. I’ll survive all sorts of scenarios, and thrive in several more. This is actual hedging, not buying USO or GLD which are playthings for day traders.

Tyler

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Re: Stocks are NOT an inflation hedge
« Reply #10 on: June 05, 2019, 03:03:34 PM »
True, but the chart posted as evidence that it's not a hedge against inflation is not evidence supporting that conclusion.

I agree that presenting the table out of context doesn't really do Israelsen's argument justice.  IMO it's well worth the time to read the full article with an open mind.  His message is less about picking on the shortcomings of stocks and more about promoting the inflation-hedging benefits of other assets in a diversified portfolio. 
« Last Edit: June 08, 2019, 10:51:27 AM by Tyler »

Andy R

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Re: Stocks are NOT an inflation hedge
« Reply #11 on: June 05, 2019, 08:19:38 PM »
Interesting article.

The question begs to be asked whether governments is now aware of which economic levers they need to pull to maintain inflation within a their target of around 2-3% and if so how useful is any of this going forward.

Radagast

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Re: Stocks are NOT an inflation hedge
« Reply #12 on: June 05, 2019, 08:59:03 PM »
Inflation affects the values of stock things like earnings, dividends, book value, and growth. Things like earnings, dividends, book value, and growth affect stock prices. So yes, in the short run inflation may have a negative impact, positive impact, or no particular effect on stock prices. Over the long term, if the economy and market are otherwise doing OK, stocks will absolutely hedge inflation. Like Ben said, in the short term stocks are a voting mechanism, in the long term a weighing mechanism. If they didn't, pretty soon stocks would be paying 20% real dividends from stable prosperous companies and getting rich would be dead simple.

I am ok with the 7 slice portfolio from the link though. It meets the requirements: at least 50% stocks, not more than 50% single country stocks, at least 10% bonds, not more than 40% bonds, significant international exposure. Though I would recommend adding an 8th slice of VSS, thus raising the very import stock allocation and bringing international exposure to Swensen's target 25%.

vand

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Re: Stocks are NOT an inflation hedge
« Reply #13 on: June 06, 2019, 02:18:36 AM »
Its still a hedge against inflation because the real returns are still positive above inflation.

Again, false thinking. Clearly, stocks prefer an environment of lower inflation. So while they may still have positive real returns when inflation is above the median level, what happens when inflation goes significantly higher...? Stocks will underperform even further, and that does not exclude negative real returns.

wageslave23

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Re: Stocks are NOT an inflation hedge
« Reply #14 on: June 06, 2019, 09:08:19 AM »
Its still a hedge against inflation because the real returns are still positive above inflation.

Again, false thinking. Clearly, stocks prefer an environment of lower inflation. So while they may still have positive real returns when inflation is above the median level, what happens when inflation goes significantly higher...? Stocks will underperform even further, and that does not exclude negative real returns.

I thought that was the point of the "high inflationary" periods chart?  I guess if we are talking about Venezuela type inflation then yes gold is the place to be because that means the whole economy is in the shitter.  But think logically about why moderately high inflation would be bad for companies?  Its not, in the short term there may be some stickiness, but overall they are getting more money for their products and services and they are paying more for the raw inputs.  It should not affect their profits.

ChpBstrd

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Re: Stocks are NOT an inflation hedge
« Reply #15 on: June 06, 2019, 10:58:05 AM »
Its still a hedge against inflation because the real returns are still positive above inflation.

Again, false thinking. Clearly, stocks prefer an environment of lower inflation. So while they may still have positive real returns when inflation is above the median level, what happens when inflation goes significantly higher...? Stocks will underperform even further, and that does not exclude negative real returns.

I thought that was the point of the "high inflationary" periods chart?  I guess if we are talking about Venezuela type inflation then yes gold is the place to be because that means the whole economy is in the shitter.  But think logically about why moderately high inflation would be bad for companies?  Its not, in the short term there may be some stickiness, but overall they are getting more money for their products and services and they are paying more for the raw inputs.  It should not affect their profits.

There are, of course, what economists call “menu costs” as in the restaurant must pay to print new menus with higher prices more frequently in a high inflation economy.

There are also companies operating on multi-year contracts. If these were bid based on low inflation expectations but then reality turns out to be different, those firms will lose money for a couple of years. They will also bid their next contracts with high inflationary assumptions, creating a cycle of inflationary expectations and higher prices that trickle through supply chains.

Third, a sudden increase in inflation may trigger a sudden increase in wage demands by workers (who work at many companies locked into multi-year contracts). Strikes and wage hikes will be demanded in advance of inflation if inflation is expected to be high.

Then there is the impact of rising interest rates, which obviously affect the earnings of indebted companies. Some highly levered companies will have to spend years of their cash flow paying down debts they accumulated back in the low interest rate era when having more leverage was optimal.

In the long term, these issues will sort out around the new normal inflation rate, but we can expect the variability itself to hit corporate earnings for at least the next 5 years.

dougules

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Re: Stocks are NOT an inflation hedge
« Reply #16 on: June 06, 2019, 11:12:48 AM »
Looking at stocks over the course of a single year doesn't make sense.  That's way too short-term for stocks.  A better question is how well do they track inflation over decades not years.   

bacchi

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Re: Stocks are NOT an inflation hedge
« Reply #17 on: June 06, 2019, 11:18:39 AM »
In the long term, these issues will sort out around the new normal inflation rate, but we can expect the variability itself to hit corporate earnings for at least the next 5 years.

Post-WW2 corporate profits reached a low in 1982. From a quick search -- there were a lot of papers published in the early 80s --  it was because of contracts, as you mentioned. Companies were paying $10 to a supplier who now needed $11 to be profitable, and so on.


Radagast

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Re: Stocks are NOT an inflation hedge
« Reply #18 on: June 06, 2019, 08:48:20 PM »
Another point, high inflation is not necessarily bad for stocks either. US markets have appeared as sensitive little babies. I recall Israel had very high stock returns with 17% annualized inflation. So either saying inflation above 3% is bad is either a narrative fallacy (believing a good story because it is a good story with no attempt at verification) or there is some other factor, like "unexpected inflation is bad for stocks." See Bill Bernstein Deep Risk for discussion of the risks of inflation. Or Dalio's Big Debt Crises.

TheHardenedInvestor

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Re: Stocks are NOT an inflation hedge
« Reply #19 on: June 07, 2019, 04:37:21 AM »
Its still a hedge against inflation because the real returns are still positive above inflation.

Again, false thinking. Clearly, stocks prefer an environment of lower inflation. So while they may still have positive real returns when inflation is above the median level, what happens when inflation goes significantly higher...? Stocks will underperform even further, and that does not exclude negative real returns.

Cool, cool, cool, cool, cool, I’ll take your stocks.

pecunia

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Re: Stocks are NOT an inflation hedge
« Reply #20 on: June 09, 2019, 07:49:43 PM »
Seems like I remember two big causes of inflation were the oil price jumping sky high and government deficit spending.  Well - Seems like the oil supply is pretty good now.  Now the government thing - Seems like inflation should be kicking us in the butt pretty quick as Uncle Sam is spending more than he's got.  Spending money you don't got is like printing money you shouldn't be printing.

The Weimar Republic printed money in a big way in years gone by.  People used to bring wheel barrows full of money to buy bread.

Stocks are a piece of a company.  Unless they are playing games with the stocks, isn't that like owning some of the assets of the company?  These assets could include machinery, land and even gold in some cases.

vand

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Re: Stocks are NOT an inflation hedge
« Reply #21 on: June 10, 2019, 03:11:35 AM »
Stocks can tolerate moderate inflation, however when it gets too high they have a hard time. The reasons for this should be obvious if you consider what inflation does; it destroys the profit signalling mechanism that free markets needs to efficiently allocate resources, and makes forecasting much harder, so companies are less able to commit to long term capital projects.

The argument that holding stocks throughout inflationary periods is permabull thinking. Stocks have done well in spite of these periods, not because of them. Do you think holders of Venezuelan stocks are patting themselves on the back and reassuring themselves that they've got a great investment on their hands right now once they get through this period of inflation? Or do you think they wished they had had their wealth preserved in hard assets?

What happens when inflation just keeps going up, year on year on year, instead of just returning to the happy 2-3% band that most of today's investors have only ever known? Paradigms change, and that is why you should have a hedge.

@Radagast , as someone who has evidently read some Dalio, you should know his favourable views on gold and commodities as inflation hedging assets.
« Last Edit: June 10, 2019, 03:36:17 AM by vand »

pecunia

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Re: Stocks are NOT an inflation hedge
« Reply #22 on: June 10, 2019, 06:07:53 AM »
There's another angle on this that really bears more impact than at any other time in history.  I refer to technological innovation.  The rate of technology change is not linear.  It is exponential.  Where do yu benefit from these changes?  The benefit is in the market.  As these changes are implemented, new products and new efficiencies in production occur.  This brings a better life for humanity and buoys the market.  Of course the market will still have its normal ups and downs.

Gold will just sit there looking back at you telling you.  If gold could talk he'd say, "Hey guy I am still here.  You're not going anywhere with me.  Someday, you will sell me and get part of your money back."

DalioGold10

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Re: Stocks are NOT an inflation hedge
« Reply #23 on: June 10, 2019, 06:43:40 AM »
There's another angle on this that really bears more impact than at any other time in history.  I refer to technological innovation.  The rate of technology change is not linear.  It is exponential.  Where do yu benefit from these changes?  The benefit is in the market.  As these changes are implemented, new products and new efficiencies in production occur.  This brings a better life for humanity and buoys the market.  Of course the market will still have its normal ups and downs.

Gold will just sit there looking back at you telling you.  If gold could talk he'd say, "Hey guy I am still here.  You're not going anywhere with me.  Someday, you will sell me and get part of your money back."

Look at Gold in terms of AA and not as a single asset.
It is a very powerful and uncorrelated asset which shelters your investment in times of uncertainty and distress. Gold  increases the return of your portfolio via rebalancing.

vand

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Re: Stocks are NOT an inflation hedge
« Reply #24 on: June 10, 2019, 04:14:55 PM »
This is a good article which looks at many different asset classes and their relationship with inflation:

https://www.schroders.com/en/sysglobalassets/staticfiles/schroders/sites/americas/canada/documents/investment-perspective-what-are-the-inflation-beating-asset-classes.pdf

Different assets have different strengths and weaknesses - no surprises there, really. There's no single asset class that is good at everything. Want strong growth? Then don't be surprised to get smashed when inflation spikes. Want predictability of returns? Then be prepared to surrender a lot of long term growth. etc.

vand

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Re: Stocks are NOT an inflation hedge
« Reply #25 on: June 10, 2019, 04:29:53 PM »
There's another angle on this that really bears more impact than at any other time in history.  I refer to technological innovation.  The rate of technology change is not linear.  It is exponential.  Where do yu benefit from these changes?  The benefit is in the market.  As these changes are implemented, new products and new efficiencies in production occur.  This brings a better life for humanity and buoys the market.  Of course the market will still have its normal ups and downs.

Gold will just sit there looking back at you telling you.  If gold could talk he'd say, "Hey guy I am still here.  You're not going anywhere with me.  Someday, you will sell me and get part of your money back."

I don't disagree with your point; competition from market forces spurs technological innovation which, together with ever increasing capital to leverage results in long term increase in productivity. This is the force which propels the equities market and enables it to have superior long term growth to other asset classes.

Whether you can classify this as "exponential" is debatable. Technological progress has been ongoing since man first learnt to make fire and create a spear tip, and it will continue indefinitely as you say, limited only by man's own ingenuity.

Gold "just sits there" as you observe, but has more than held its own over thousands of years of history during which time Man went from the Spear to the iPhone. you can say the same about other asset classes; a house "just sits there". It quintessentially does the same thing as houses did 50 or 200 years ago, yet houses too have risen in value over time.

pecunia

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Re: Stocks are NOT an inflation hedge
« Reply #26 on: June 10, 2019, 08:43:51 PM »
They say, "They are not making any more land."  So, people buy it and speculate with it.  The difference between land and gold is that land may be used for a passive income.

Likewise, they are not making any more gold.  At least not a lot unless they find something akin to the Comstock Lode.  I haven't read the links you provided, but when hard times hit,.......isn't there less money around?  If there is less money around, wouldn't that affect gold prices?  On the other hand, hard times don't usually hit all over so maybe it is more constant.

Side Note:  I have noted with these better times that the price of many items seems to be creeping up.

http://www.infomine.com/investment/metal-prices/gold/6-month/  Gold may be no exception.

Radagast

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Re: Stocks are NOT an inflation hedge
« Reply #27 on: June 10, 2019, 09:21:33 PM »
@Radagast , as someone who has evidently read some Dalio, you should know his favourable views on gold and commodities as inflation hedging assets.
Source? 'cause you are probably right but he didn't say anything about it in Big Debt Crises, and I have no intention of reading but I bet he doesn't mention it in Principles either. All I have seen is people on the internet say that they read that somebody wrote that Ray said so to them.

I have already said so, but I am pretty sure that you didn't read when I said I think this is probably the most honest attempt at figuring out what Dalio actually intended: https://www.bogleheads.org/forum/viewtopic.php?t=206028

BTW I read every link you posted. How many of the sources I posted have you read? ;) Deep Risk, Skating Where the Puck Was, Big Debt Crises, The Four Pillars of Investing, Fooled by Randomness, The Black Swan, have you even read The Permanent Portfolio? Lots of contemplation on the subject out there.

vand

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Re: Stocks are NOT an inflation hedge
« Reply #28 on: June 11, 2019, 02:35:03 AM »
They say, "They are not making any more land."  So, people buy it and speculate with it.  The difference between land and gold is that land may be used for a passive income.

Likewise, they are not making any more gold.  At least not a lot unless they find something akin to the Comstock Lode.  I haven't read the links you provided, but when hard times hit,.......isn't there less money around?  If there is less money around, wouldn't that affect gold prices?  On the other hand, hard times don't usually hit all over so maybe it is more constant.

Side Note:  I have noted with these better times that the price of many items seems to be creeping up.

http://www.infomine.com/investment/metal-prices/gold/6-month/  Gold may be no exception.


> when hard times hit,.......isn't there less money around?

In an era of infinitely elastic money supply, there's always plenty of "money" around. It's usually just it the form of overwhelming debt.

I could write a lot on why gold works in a portfolio, but to really understand it necessitates a crashcourse in monetary history and what money actually is. It may suffice to say that gold is naturally horded by those who desire it (as often observed... what else do you do with it?) - it is seen as a wealth store of last resort, and a defensive asset, which is why it works so well as a divisifier to balance portfolios that contain risk-on paper assets (even bonds are often a risk-on trade.. you are, after all, lending someone money).

It's during times of crisis that governments resort to printing more currency as a means of meeting their obligations, usually at the same time that production in the economy is decreasing. More currency chasing fewer goods is an inflationary recipe (provided money velocity doesn't fall too). Under such conditions there is usually a preferential shift to hard assets such as gold/copper/oil that cannot be diluted at the whim of a central banker's keyboard.
« Last Edit: June 11, 2019, 03:04:45 AM by vand »

crammarc

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Re: Stocks are NOT an inflation hedge
« Reply #29 on: June 11, 2019, 09:20:36 AM »
Does anyone consider a fixed low interest loan to be a good inflation hedge i.e. a mortgage?  If money becomes worth less due to inflation this appears to me to have an inverse affect on your future debt obligations. If you are concerned that governments will just be printing more money wouldn't it make sense to just never pay of a mortgage early? 

I may be missing something but I am thinking that keeping low interest debt is better hedge against inflation because debt is directly correlated to the value of money.  Also, in the event that inflation remains low you are able to invest or deploy the money you could have spent on the debt into anything else.  Obviously the downside is the interest payments, but even gold has downsides in opportunity cost so nothing is perfect.

Tyson

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Re: Stocks are NOT an inflation hedge
« Reply #30 on: June 11, 2019, 10:24:58 AM »
Does anyone consider a fixed low interest loan to be a good inflation hedge i.e. a mortgage?  If money becomes worth less due to inflation this appears to me to have an inverse affect on your future debt obligations. If you are concerned that governments will just be printing more money wouldn't it make sense to just never pay of a mortgage early? 

I may be missing something but I am thinking that keeping low interest debt is better hedge against inflation because debt is directly correlated to the value of money.  Also, in the event that inflation remains low you are able to invest or deploy the money you could have spent on the debt into anything else.  Obviously the downside is the interest payments, but even gold has downsides in opportunity cost so nothing is perfect.

You are correct, and there's a thread here on MMM called "Don't Pay off your Mortgage" that goes into quite a bit of detail on it.

vand

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Re: Stocks are NOT an inflation hedge
« Reply #31 on: June 13, 2019, 03:20:43 AM »
Does anyone consider a fixed low interest loan to be a good inflation hedge i.e. a mortgage?  If money becomes worth less due to inflation this appears to me to have an inverse affect on your future debt obligations. If you are concerned that governments will just be printing more money wouldn't it make sense to just never pay of a mortgage early? 

I may be missing something but I am thinking that keeping low interest debt is better hedge against inflation because debt is directly correlated to the value of money.  Also, in the event that inflation remains low you are able to invest or deploy the money you could have spent on the debt into anything else.  Obviously the downside is the interest payments, but even gold has downsides in opportunity cost so nothing is perfect.

Economically speaking yes, you are borrowing at a fixed rate on an inflation-adjusting asset and paying off in depreciated dollars tomorrow. However, I would see it more as a long term hedge, not really a portfolio hedge.

However, nothing is without risk.

What if we, instead of inflation, we get deflation? There are people out there who believe this is destined to happen due to demographic reasons, similar to Japan or even during the depression. The debt becomes an ever-increasing burden in that scenario.

Also, you are literally risking the roof over your head if you want to do this; under an inflationary shock and the hedge works beautifully, but is that going to matter if it also means the economy goes belly, you lose your job, and your home is under threat of repossession? It is rather defeating the point of having a hedge if it means you are unnecessarily taking on some other form of tail-end risk.

Tyson

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Re: Stocks are NOT an inflation hedge
« Reply #32 on: June 13, 2019, 08:47:26 AM »
Does anyone consider a fixed low interest loan to be a good inflation hedge i.e. a mortgage?  If money becomes worth less due to inflation this appears to me to have an inverse affect on your future debt obligations. If you are concerned that governments will just be printing more money wouldn't it make sense to just never pay of a mortgage early? 

I may be missing something but I am thinking that keeping low interest debt is better hedge against inflation because debt is directly correlated to the value of money.  Also, in the event that inflation remains low you are able to invest or deploy the money you could have spent on the debt into anything else.  Obviously the downside is the interest payments, but even gold has downsides in opportunity cost so nothing is perfect.

Economically speaking yes, you are borrowing at a fixed rate on an inflation-adjusting asset and paying off in depreciated dollars tomorrow. However, I would see it more as a long term hedge, not really a portfolio hedge.

However, nothing is without risk.

What if we, instead of inflation, we get deflation? There are people out there who believe this is destined to happen due to demographic reasons, similar to Japan or even during the depression. The debt becomes an ever-increasing burden in that scenario.

Also, you are literally risking the roof over your head if you want to do this; under an inflationary shock and the hedge works beautifully, but is that going to matter if it also means the economy goes belly, you lose your job, and your home is under threat of repossession? It is rather defeating the point of having a hedge if it means you are unnecessarily taking on some other form of tail-end risk.

I should point out that if you pay extra to the mortgage, it's actually very risky unless you can pay it all off at once. 

On the other hand, if you DON'T pay extra to the mortgage and save/invest that money instead, then you will have a giant pile of cash (ie, stocks and bonds) that you can draw on in the case of job loss and/or economic fallout. 

bacchi

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Re: Stocks are NOT an inflation hedge
« Reply #33 on: June 13, 2019, 09:20:57 AM »
Also, you are literally risking the roof over your head if you want to do this; under an inflationary shock and the hedge works beautifully, but is that going to matter if it also means the economy goes belly, you lose your job, and your home is under threat of repossession? It is rather defeating the point of having a hedge if it means you are unnecessarily taking on some other form of tail-end risk.

I should point out that if you pay extra to the mortgage, it's actually very risky unless you can pay it all off at once. 

On the other hand, if you DON'T pay extra to the mortgage and save/invest that money instead, then you will have a giant pile of cash (ie, stocks and bonds) that you can draw on in the case of job loss and/or economic fallout.

This should be in a FAQ somewhere.

crammarc

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Re: Stocks are NOT an inflation hedge
« Reply #34 on: June 13, 2019, 10:12:22 AM »
Does anyone consider a fixed low interest loan to be a good inflation hedge i.e. a mortgage?  If money becomes worth less due to inflation this appears to me to have an inverse affect on your future debt obligations. If you are concerned that governments will just be printing more money wouldn't it make sense to just never pay of a mortgage early? 

I may be missing something but I am thinking that keeping low interest debt is better hedge against inflation because debt is directly correlated to the value of money.  Also, in the event that inflation remains low you are able to invest or deploy the money you could have spent on the debt into anything else.  Obviously the downside is the interest payments, but even gold has downsides in opportunity cost so nothing is perfect.

Economically speaking yes, you are borrowing at a fixed rate on an inflation-adjusting asset and paying off in depreciated dollars tomorrow. However, I would see it more as a long term hedge, not really a portfolio hedge.

However, nothing is without risk.

What if we, instead of inflation, we get deflation? There are people out there who believe this is destined to happen due to demographic reasons, similar to Japan or even during the depression. The debt becomes an ever-increasing burden in that scenario.

Also, you are literally risking the roof over your head if you want to do this; under an inflationary shock and the hedge works beautifully, but is that going to matter if it also means the economy goes belly, you lose your job, and your home is under threat of repossession? It is rather defeating the point of having a hedge if it means you are unnecessarily taking on some other form of tail-end risk.

Thanks for your input.

A mortgage doesn't have to be on ones primary residence.  But I appreciate the point that while its a hedge you are keeping/adding a risk of losing the property.  I agree that deflation would work opposite but in a deflationary environment I would plan on paying that debt down early.

To bring this back around to the OP
It is commodities and hard assets (inc real estate) that are the really effective hedge during inflationary periods.
I'm mulling the following two portfolios

Commodity/Real Estate hedged
40%  Equities
30%  Commodities/Gold
20%  Real Estate (for hypothetical purposes lets say this is without debt)
10%  Cash/Bonds

vs reducing the commodities/gold and instead leveraging the real estate

40%  Equities
10%  Commodities/Gold
30%  Real Estate (leveraged with fixed low interest debt)
20%  Cash/Bonds

Low inflation years: Equities/Real estate/Bond exposure all outperform vs commodities.  The debt increases risk but at a fixed rate I think the risk is mitigated by the upside from the other asset classes.  Also, if we get to deflation the additional Cash/bond allocation will allow you to reduce the debt.

High inflation years: Equities will do well but underperform vs commodities. The debt risk is decreased significantly.  The Cash/bond will significantly underperform vs commodities. The addition real estate exposure (including leverage) should close the gap most of the way vs commodities.

My currently thinking is that while commodities are the best class for high inflation scenarios but they do so poorly in low inflation scenarios I would prefer to carry additional real estate debt and less commodities.  I am not experienced with commodities so I may be underestimating them and would love to hear feedback.

dougules

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Re: Stocks are NOT an inflation hedge
« Reply #35 on: June 13, 2019, 11:00:53 AM »
Also, you are literally risking the roof over your head if you want to do this; under an inflationary shock and the hedge works beautifully, but is that going to matter if it also means the economy goes belly, you lose your job, and your home is under threat of repossession? It is rather defeating the point of having a hedge if it means you are unnecessarily taking on some other form of tail-end risk.

I should point out that if you pay extra to the mortgage, it's actually very risky unless you can pay it all off at once. 

On the other hand, if you DON'T pay extra to the mortgage and save/invest that money instead, then you will have a giant pile of cash (ie, stocks and bonds) that you can draw on in the case of job loss and/or economic fallout.

This should be in a FAQ somewhere.

The whole pay mortgage vs invest conversation probably should be a sticky thread except that it gets surprisingly controversial.  It gets almost as bad as the political threads. 

Telecaster

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Re: Stocks are NOT an inflation hedge
« Reply #36 on: June 13, 2019, 11:13:18 AM »
What if we, instead of inflation, we get deflation? There are people out there who believe this is destined to happen due to demographic reasons, similar to Japan or even during the depression. The debt becomes an ever-increasing burden in that scenario.

The thing to do in that case is pay it off.   

ChpBstrd

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Re: Stocks are NOT an inflation hedge
« Reply #37 on: June 13, 2019, 01:04:29 PM »
What if we, instead of inflation, we get deflation? There are people out there who believe this is destined to happen due to demographic reasons, similar to Japan or even during the depression. The debt becomes an ever-increasing burden in that scenario.

The thing to do in that case is pay it off.

You would also have the option of refinancing, assuming government subsidies for mortgages were still in effect.

Radagast

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Re: Stocks are NOT an inflation hedge
« Reply #38 on: June 13, 2019, 07:52:59 PM »
What if we, instead of inflation, we get deflation? There are people out there who believe this is destined to happen due to demographic reasons, similar to Japan or even during the depression. The debt becomes an ever-increasing burden in that scenario.

The thing to do in that case is pay it off.

You would also have the option of refinancing, assuming government subsidies for mortgages were still in effect.
For certain. If you could refinance from 4% to 3% to 2% to 1% that would be amazing.

ChpBstrd

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Re: Stocks are NOT an inflation hedge
« Reply #39 on: June 13, 2019, 08:11:32 PM »
What if we, instead of inflation, we get deflation? There are people out there who believe this is destined to happen due to demographic reasons, similar to Japan or even during the depression. The debt becomes an ever-increasing burden in that scenario.

The thing to do in that case is pay it off.

You would also have the option of refinancing, assuming government subsidies for mortgages were still in effect.
For certain. If you could refinance from 4% to 3% to 2% to 1% that would be amazing.
0.41% fixed rate mortgages are the reality right now in Japan.
https://www.ceicdata.com/en/japan/mortgage-rate

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Re: Stocks are NOT an inflation hedge
« Reply #40 on: June 14, 2019, 03:48:35 AM »
What if we, instead of inflation, we get deflation? There are people out there who believe this is destined to happen due to demographic reasons, similar to Japan or even during the depression. The debt becomes an ever-increasing burden in that scenario.

The thing to do in that case is pay it off.

Pay it off with what, though? Equities don't thrive during deflation, so your stock holdings are likely to be depressed. Are you going to liquidate those? Are you going to have a large pile of cash or short term treasuries sitting there that you can use to pay it down? Are you going to pay it down over 30 years as apparently "investment beats paying the mortgage" ?

You can see there are no easy answers.

It boils down to opportunity cost. Having a portfolio that works well - or even adequately - in many different scenarios necessitates trade offs that means it won't work as well as a portfolio that is specialised for the current climate. Stock-heavy portfolios are specialised for the current benign climate.. I would not be surprised to see them not working as well if or when that climate changes.
« Last Edit: June 14, 2019, 03:50:34 AM by vand »

Tyson

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Re: Stocks are NOT an inflation hedge
« Reply #41 on: June 14, 2019, 09:11:09 AM »
What if we, instead of inflation, we get deflation? There are people out there who believe this is destined to happen due to demographic reasons, similar to Japan or even during the depression. The debt becomes an ever-increasing burden in that scenario.

The thing to do in that case is pay it off.

Pay it off with what, though? Equities don't thrive during deflation, so your stock holdings are likely to be depressed. Are you going to liquidate those? Are you going to have a large pile of cash or short term treasuries sitting there that you can use to pay it down? Are you going to pay it down over 30 years as apparently "investment beats paying the mortgage" ?

You can see there are no easy answers.

It boils down to opportunity cost. Having a portfolio that works well - or even adequately - in many different scenarios necessitates trade offs that means it won't work as well as a portfolio that is specialised for the current climate. Stock-heavy portfolios are specialised for the current benign climate.. I would not be surprised to see them not working as well if or when that climate changes.

What thrives during deflation?

ChpBstrd

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Re: Stocks are NOT an inflation hedge
« Reply #42 on: June 14, 2019, 09:25:41 AM »
What if we, instead of inflation, we get deflation? There are people out there who believe this is destined to happen due to demographic reasons, similar to Japan or even during the depression. The debt becomes an ever-increasing burden in that scenario.

The thing to do in that case is pay it off.

Pay it off with what, though? Equities don't thrive during deflation, so your stock holdings are likely to be depressed. Are you going to liquidate those? Are you going to have a large pile of cash or short term treasuries sitting there that you can use to pay it down? Are you going to pay it down over 30 years as apparently "investment beats paying the mortgage" ?

You can see there are no easy answers.

It boils down to opportunity cost. Having a portfolio that works well - or even adequately - in many different scenarios necessitates trade offs that means it won't work as well as a portfolio that is specialised for the current climate. Stock-heavy portfolios are specialised for the current benign climate.. I would not be surprised to see them not working as well if or when that climate changes.

What thrives during deflation?

Cash and government bonds.

bacchi

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Re: Stocks are NOT an inflation hedge
« Reply #43 on: June 14, 2019, 09:50:15 AM »
Pay it off with what, though? Equities don't thrive during deflation, so your stock holdings are likely to be depressed. Are you going to liquidate those? Are you going to have a large pile of cash or short term treasuries sitting there that you can use to pay it down? Are you going to pay it down over 30 years as apparently "investment beats paying the mortgage" ?

You can see there are no easy answers.

It boils down to opportunity cost. Having a portfolio that works well - or even adequately - in many different scenarios necessitates trade offs that means it won't work as well as a portfolio that is specialised for the current climate. Stock-heavy portfolios are specialised for the current benign climate.. I would not be surprised to see them not working as well if or when that climate changes.

What thrives during deflation?

Cash and government bonds.

If we're going to do some what-ifs, what happens if the US loses its reserve currency status?

US bond prices drop, USD loses value, US equities drop, world economy drags bringing commodities down a notch, and then where are we?


nereo

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Re: Stocks are NOT an inflation hedge
« Reply #44 on: June 14, 2019, 10:07:23 AM »
Why are we giving equal consideration to the effects of deflation - something that has happened in only 3 or 4 of the last 300 quarters (i.e. is short lived and historically has occurred ~1% of the time)?
For the US one would have to go back to the 1930s to encounter an entire year that was deflationary.

Tyson

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Re: Stocks are NOT an inflation hedge
« Reply #45 on: June 14, 2019, 10:22:54 AM »
Why are we giving equal consideration to the effects of deflation - something that has happened in only 3 or 4 of the last 300 quarters (i.e. is short lived and historically has occurred ~1% of the time)?
For the US one would have to go back to the 1930s to encounter an entire year that was deflationary.

Both deflation and giant drops in the market both seem like they could be addressed by having a couple of years living expenses in cash, no?  Just as a short term buffer against worse case scenarios?  Use that cash in those scenarios and then switch over to drawing down your stocks/bonds like you normally would. 

BicycleB

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Re: Stocks are NOT an inflation hedge
« Reply #46 on: June 14, 2019, 10:50:15 AM »
Pay it off with what, though? Equities don't thrive during deflation, so your stock holdings are likely to be depressed. Are you going to liquidate those? Are you going to have a large pile of cash or short term treasuries sitting there that you can use to pay it down? Are you going to pay it down over 30 years as apparently "investment beats paying the mortgage" ?

You can see there are no easy answers.

It boils down to opportunity cost. Having a portfolio that works well - or even adequately - in many different scenarios necessitates trade offs that means it won't work as well as a portfolio that is specialised for the current climate. Stock-heavy portfolios are specialised for the current benign climate.. I would not be surprised to see them not working as well if or when that climate changes.

What thrives during deflation?

Cash and government bonds.

If we're going to do some what-ifs, what happens if the US loses its reserve currency status?

US bond prices drop, USD loses value, US equities drop, world economy drags bringing commodities down a notch, and then where are we?

"We" are fine... as long as those of us with foreign equity gained some relative benefit!  :)

Joking aside, it's hard to know exactly what happens in a farfetched scenario like that because it might be chaotic. Still, diversification that includes foreign equity seems like it would provide some long term shelter, combining dividends with currency protection.

Telecaster

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Re: Stocks are NOT an inflation hedge
« Reply #47 on: June 14, 2019, 11:22:19 AM »
Pay it off with what, though? Equities don't thrive during deflation, so your stock holdings are likely to be depressed. Are you going to liquidate those? Are you going to have a large pile of cash or short term treasuries sitting there that you can use to pay it down? Are you going to pay it down over 30 years as apparently "investment beats paying the mortgage" ?

You can see there are no easy answers.

It boils down to opportunity cost. Having a portfolio that works well - or even adequately - in many different scenarios necessitates trade offs that means it won't work as well as a portfolio that is specialised for the current climate. Stock-heavy portfolios are specialised for the current benign climate.. I would not be surprised to see them not working as well if or when that climate changes.

I dunno, it doesn't sound that hard.   Stocks being depressed or not really doesn't come into it.    The question to pay off or your mortgage or not boils down to "what is the best use of funds over the term of the mortgage?"    In a deflationary environment, you probably do want to pay it off.  Either pay extra, lump sum it, refinance, or whatever.   Right now, you probably don't.   The decision making logic doesn't change much, just the inputs.   

Radagast

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Re: Stocks are NOT an inflation hedge
« Reply #48 on: June 14, 2019, 10:57:13 PM »
Pay it off with what, though? Equities don't thrive during deflation, so your stock holdings are likely to be depressed. Are you going to liquidate those? Are you going to have a large pile of cash or short term treasuries sitting there that you can use to pay it down? Are you going to pay it down over 30 years as apparently "investment beats paying the mortgage" ?

You can see there are no easy answers.

It boils down to opportunity cost. Having a portfolio that works well - or even adequately - in many different scenarios necessitates trade offs that means it won't work as well as a portfolio that is specialised for the current climate. Stock-heavy portfolios are specialised for the current benign climate.. I would not be surprised to see them not working as well if or when that climate changes.

What thrives during deflation?

Cash and government bonds.

If we're going to do some what-ifs, what happens if the US loses its reserve currency status?

US bond prices drop, USD loses value, US equities drop, world economy drags bringing commodities down a notch, and then where are we?
The link to the bogleheads thread seems to indicate local currency emerging market bonds and gold.

ChpBstrd

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Re: Stocks are NOT an inflation hedge
« Reply #49 on: June 15, 2019, 09:26:06 PM »
Why are we giving equal consideration to the effects of deflation - something that has happened in only 3 or 4 of the last 300 quarters (i.e. is short lived and historically has occurred ~1% of the time)?
For the US one would have to go back to the 1930s to encounter an entire year that was deflationary.

The theory is that the U.S. is no longer growing its population like it did in the 20th century. Demographically the country is aging which reduces monetary velocity, and massive wealth inequality means most dollars are never circulated in a year and instead crowd into bubble investments. Put all that together (and tie a property bubble bow on top) and you have a Japan scenario. One has to admit the undertow is massive if we're holding unemployment under 4% with 2.5% 10 year treasury rates, record-low savings rates, decent consumer spending growth, ... and somehow inflation is still running at 2%. If that undertow increased even a tiny amount, we would be at ZIRP printing dollars like the Japanese are printing yen trying to escape deflationary gravity.