As inflation expectations rise, many investors are grappling with how to protect their portfolios, the Wall Street Journal reports.
A robust economy, combined with a new administration promising tax cuts and tariffs, has sparked concerns that inflation could make a comeback. However, traditional methods of shielding against inflation, such as investing in commodities like oil, gold, and copper, may not be as effective as they once were.
The two primary drivers of inflation are well-known: supply shocks and demand surges. Geopolitical tensions, such as the ongoing conflict in the Middle East, could potentially disrupt energy supplies, while tax cuts in an economy with near-full employment might drive up prices. However, other factors, such as tariffs and potential immigration policies, present additional complexities that challenge traditional approaches to inflation hedging.
One key issue is the evolving nature of oil markets. While oil has historically been a strong hedge against inflation driven by rising energy prices, this dynamic has changed. The global oil market is now more resilient to supply shocks due to factors such as higher production capacity, large reserves, and the US’s position as a net oil exporter. This is in stark contrast to the inflationary environment of the 1970s, when oil prices spiked in response to geopolitical events. Today, crude oil prices are relatively stable, hovering around $70 per barrel, even amid heightened tensions in the Middle East.
In addition, President-elect Donald Trump’s pro-energy stance and his selection of a fracking executive as energy secretary suggest that U.S. domestic oil production could further ease upward pressure on prices, making oil a less reliable inflation hedge in the current climate.
Another traditional inflation hedge, copper, may also lose its effectiveness in the face of changing global dynamics. Typically, commodities like copper benefit from stronger economic growth, as rising demand for industrial metals often signals increasing inflationary pressures. However, the trade policies pursued by the incoming administration, particularly tariffs, could disrupt this pattern. Tariffs on Chinese imports, for example, may dampen demand from China, the world’s largest consumer of raw materials, undermining the correlation between economic growth and commodity prices.
The potential impact of tariffs on inflation is multifaceted. In the short term, tariffs can act like a sales tax, raising the cost of goods and pushing up inflation expectations. However, the longer-term effects of tariffs could slow economic growth, which would typically reduce inflationary pressure. As a result, investors are seeing inflation expectations rise in the near term but remain relatively stable beyond five years. Tariffs, therefore, complicate the task of hedging against inflation through traditional commodities like oil or copper, as these assets may not react as expected.
Moreover, the administration’s immigration policies, including potential deportations, could further complicate the inflationary landscape. A reduction in the labor force, particularly among low-wage workers, could drive up wages in sectors like agriculture. As businesses compete to replace low-cost workers, increased labor costs could translate into higher prices, particularly for food. While agricultural futures might be a potential hedge against this specific form of inflation, they are highly volatile and require a nuanced understanding of crop cycles and market dynamics.
For those seeking a more stable inflation hedge, Treasury Inflation-Protected Securities (TIPS) stand out. TIPS are designed to provide returns that are adjusted for inflation, making them a reliable option for long-term protection against sustained inflationary pressures. However, TIPS are not immune to short-term volatility. In periods of rising interest rates, such as in 2022, TIPS can lose value as the market adjusts to higher inflation expectations. Still, with higher starting yields today, TIPS offer a better hedge against prolonged inflation than they did in the past.
Ultimately, protecting a portfolio against inflation in the current economic environment requires a more nuanced approach. While TIPS remain a solid choice for long-term protection, commodities like oil and copper may not provide the same level of security they once did. Investors may want to consider a diversified strategy that includes some exposure to energy stocks, which could benefit from a genuine oil-price shock, alongside more traditional inflation hedges.
