If there's any worry lurking larger in the minds of investors than the risk of a double-dip recession and another market crash, it'd have to be our old friend, inflation. The I-word has been making its rounds in the media and throughout investors' psyches, stoking fear that a repeat of the runaway stagflation of the 1970s is right around the corner.
But are inflation concerns overblown? And just how effective is the arsenal of inflation-fighting tools investors have at their disposal?
Tomorrow's threat
So where are the signs of rampant inflation in our economy? Well, they're nowhere to be found right now. Right now, deflation is actually more of a risk to our economy than inflation. The Consumer Price Index's year-over-year measure of inflation turned negative several months ago, the first time that has happened in more than 50 years.
Also, the spread between intermediate-term Treasuries and inflation-protected securities of the same maturity has been hovering around the same 1.5%-to-2% range for several months now, which is actually slightly lower than the long-term average. All of these signs point to inflation being a rather dormant threat right now. There's just too much excess capacity and economic weakness in our system for meaningful inflation to take hold.
But the true alarm is being sounded about the inflation that might be hiding around the corner. It's true that a massive amount of money has been pumped into our financial system in an effort to beat back the current recession. The Fed has lowered interest rates to historically low levels. While these are the correct recession-fighting policies, they will almost inevitably trigger inflation down the road. Prices may be under control right now, but tomorrow is another story.
Not so golden
So what can investors do to proactively stave off inflation? Well, many of the traditional measures we turn to may not work quite as neatly as we would believe.
For instance, gold has traditionally been thought of as an inflation hedge. And, as might be expected, gold has been rallying as of late. Gammon Gold (NYSE:GRS) has more than doubled in the past year, while Freeport-McMoRan Copper & Gold (NYSE:FCX) has nearly tripled.
But while gold has done well in past inflationary periods, there is a good chance that much of the current gold rally is being driven by worries over a weakening U.S. dollar. If the dollar should strengthen, odds are good that gold would get knocked down, even if inflation starts to gain momentum. And even if gold does turn out to be a good inflation hedge this time around, gold has not done well as a wealth-builder over the long run. Although it has done very well in the so-called lost decade for stocks, gold has significantly trailed stock returns over longer periods of time.
TIPS are another commonly sought inflation-stopper. These bonds are indexed to inflation, so the face value of the bond rises in lockstep with the CPI. However, although the CPI is a useful inflation measure, it doesn't reflect all costs a consumer pays, and your expenses may vary considerably from what the CPI indicates. Even though TIPS won't provide a perfect inflation hedge, they're a decent option if you are a fixed-income investor and wish to preserve your purchasing power.
Fortunately, you probably already own one of the best inflation fighters around -- stocks. Over the long haul, stocks have provided inflation-beating returns. To bolster your portfolio's inflation-busting powers, consider picking up a few consumer stocks with strong market share that will have some wiggle room to raise prices. Names like Philip Morris (NYSE:PM), Coca-Cola (NYSE:KO), and Altria Group (NYSE:MO) should successfully deal with increased prices down the road.
Preparing for the worst
One veteran fund manager who is concerned about inflation is David Winters, manager of the Wintergreen Fund (WGRNX). Before leaving to start his own firm, Winters ran the Mutual Global Discovery (TEDIX) fund from 2000 to 2005, racking up 10% annual returns, compared with a 1% annualized loss for the average world stock fund.
In a recent interview, Winters noted that while pricing pressures were minimal right now, he is very concerned about future inflation, given the amount of money being printed across the globe. As a result, Winters is favoring companies that he feels will be able to retain pricing power, such as U.K.-based British American Tobacco. Closer to home, Winters is also a fan of Warren Buffett's Berkshire Hathaway (NYSE:BRK-B) and McDonald's (NYSE:MCD).
Take a hint from David Winters and make sure you take advantage of the best tool for managing inflation now -- stocks. The inflation front may look secure now, but once prices start to pick up their pace, the optimal time for preparing your defenses will have already passed. Snap up some bargains across the globe that can thrive in an inflationary environment and you'll be on your way to snuffing out inflation before it gets a hold of your portfolio.
