We've watched for a few years now as the Federal Reserve and U.S. Treasury have pumped money into the flagging U.S. economy in hopes of bringing it back to life and jump-starting growth. Optimists like me would say that it's working, but even then it's impossible not to concede that it's not working all that well.
And for the lackluster growth in gross domestic product and ailing job market, we still face the risk of inflation as the loose monetary policy continues to snake its way through the economy. On the consumer level we haven't seen much inflation yet, but companies such as Starbucks
Fed Chairman Ben Bernanke says we shouldn't be worried about inflation. My fellow Fool Rich Smith thinks he's mistaken.
So should you start preparing your portfolio for inflation?
Trouble is ...
It's not terribly clear what equity investors' best move is when it comes to dealing with inflation. Using data from the U.S. Department of Labor and Yale professor Robert Shiller, I found that the correlation between annual inflation and nominal changes in the S&P 500 (and its equivalent prior to 1957) between 1914 and 2010 was 0.08. What does that mean? It means that there's a weak enough relationship between the two that it would be tough to say what the S&P will do based on inflation. The correlation changes over different time periods -- it's -0.11 over the past 50 years and 0.12 over the past 30 -- but the relationship remains pretty weak.
But could there be reason to be optimistic about inflation's return? Writing for Forbes, Martin Fridson suggested that it's the rate of change of inflation and not inflation itself that matters. As such, he explains that higher inflation could be good for equity investors right now.
Meanwhile, a Peter Hodson article in the Financial Post points out that some companies may be able to use inflation to raise prices faster than their costs and thereby boost profit. Think about companies like Accenture
Of course as with so much else in the stock market, the real factor at play here -- and Fridson also notes this -- is investors' expectations. Inflation could be 800%, but if the market is already priced for 1,000% inflation then investors could end up pleasantly surprised.
The way some stocks are priced right now, I find it hard to believe that equity investors will be caught flat-footed if inflation does rear up. If the market was truly ignoring inflation risks, there's no way that Ford
So circling back to the question that led you here in the first place, if you're currently investing in quality companies at low prices, you may be more prepared for inflation than you think.
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Accenture is a Motley Fool Inside Value selection. Ford and Starbucks are Motley Fool Stock Advisor picks. PepsiCo is a Motley Fool Income Investor picks. Motley Fool Options has recommended a diagonal call position on PepsiCo. The Fool owns shares of Ford, IBM, JPMorgan Chase, PepsiCo, and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
Fool contributor Matt Koppenheffer does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.