Inflationary trend lands advisers in unfamiliar territory

The unrelenting effects of higher inflation and stock market volatility have financial advisers employing new and creative tactics to try and shield client portfolios. But sometimes, it boils down to sticking with the basics.

“The best long-term hedge against inflation is an allocation to equities and other growth-oriented investments,” said Susan Mitcheltree, a partner at Berman McAleer.

“There are many sources of investment return, some of which come from the appreciation of the asset or the income it produces; others, especially in markets like these, come from circumventing avoidable losses, most of which come about through behavioral mistakes, which in turn lead to a permanent loss of capital,” Micheltree said. “Whether it is an investment return earned or an investment loss avoided, in the end, both equal real dollars in your client's pocket.”

For a lot of advisers, seeing inflation at a 40-year-high is brand-new territory for both them and their clients.

“This will sound overly simplistic, but the first-order discussion is reviewing their overall allocation to stocks,” said Kevin Brady, vice president at Wealthspire Advisors.

“While stocks historically react negatively to rising inflation, they have a more positive relationship when inflation is either steady or trending lower,” he said. “That remains true even when inflation is still higher than average. This, combined with the fact that stocks are a long-term inflation hedge by the fact that they have appreciation potential over time, is why it is usually a first item on the discussion list.”

The most recent calculation shows inflation at around 8.5%, which is leading the Federal Reserve to raise interest rates to tamp down access to capital. But these efforts are being thwarted by Biden administration policies, including proposals for hundreds of billions of dollars worth of student debt relief, that fuel inflationary pressure.

This is all being reflected on a real-time basis by the stock market, which has seen wild recent swings by the S&P 500 Index, which is up slightly from its low point in June but still down nearly 13% for the year.

Dennis Nolte,senior vice president at Seacoast Investment Services, is struggling to find a balance among the mounting economic risks while also trying to gauge the strength and direction of inflation.

“Since we started talking about inflation in the second half of 2020, we added commodity funds, energy, REITs and tech,” Nolte said. “However, now since we perhaps have seen the peak of inflation, though we think it will stubbornly persist at a higher level than we've become accustomed to over the last 40 years, and recession is a greater risk than inflation, we think cash, the asset that doesn't pay any adviser, is becoming more attractive.”

Nolte said a money market rate of less than 2% is still losing pace with inflation, but “it certainly doesn’t lose principal.”

“We think the best positioning now is for a recession, meaning utilities, health care, consumer staples, and bonds are becoming attractive,” he said. “And for those interested just in capital preservation, TIPs and Treasuries and CDs with two- and three-year maturities seem to be on the docket. We figure it's going to be a cold winter for the equity markets.”

Paul Schatz, president of Heritage Capital, is letting the future be his guide to navigating inflation, and that means allocations to I bonds that lock up client capital while paying safe and attractive yields.

“The best inflation hedges are at their best long before investors recognize inflation is problematic,” he said. “The issue is that when the economy is this long into inflation, the markets are looking well past peak inflation and on to the next theme.”