Inflation or Recession?

Bill Parrott |
Categories
Wealth Management

Inflation is climbing, while some market indicators are predicting a recession. The market gauges are in flux, leaving investors confused and concerned about their financial future. Which battle should you fight – inflation or recession?

The current inflation rate is 6.41%. The rate is down sharply from its peak but up significantly from the low. The recent readings indicate a flattening, or, in other words, the inflation rate may hover around the current level for a while. The 6.41% inflation rate is crushing, and at that rate, the value of your dollar will drop by 46% over ten years as the value of goods and services will continue to rise. Have you purchased eggs lately?

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On the other hand, a few market indicators forecast a recession. The 10-2 Year Treasury Yield Curve is inverted, where the yield on the US 10-Year Treasury is lower than the yield on the US 2-Year: the 10-year yields 3.86%, the rate on the 2-year is 4.62%, a difference of negative 0.76%. What does this mean for investors? Historically, when the yield curve inverts, a recession follows, but it's not instantaneous, and it could be several months if one arrives, if at all.

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What should you do to protect your portfolio from inflation or a recession? Let's look at a few ideas.

  • Stocks are an excellent hedge against inflation. If a company raises its prices to combat inflation, it will eventually earn more money, and when they make money, you could also. For example, Microsoft earned $1.21 per share in 2006 and $9.21 per share in 2022, an increase of 661%. The price of Microsoft increased by 817% during that period.
  • Bonds are an excellent hedge against a recession. If a downturn arrives, then interest rates will fall. The Federal Reserve is raising interest rates now but will lower them if our economy falters, and when rates drop, bond prices rise.
  • Cash is a short-term haven. A robust cash allocation can protect your portfolio against a stock market correction, but it will hinder the growth of your portfolio. US Treasuries now offer an attractive rate of nearly 5%, allowing you to earn some interest if you decide to sell your stocks or long-term bonds.
  • Alternative investments may protect your portfolio against inflation or a market correction. A real estate investment trust can perform well when inflation rises; everybody loves real estate primarily because their homes have appreciated over time. Gold is a decent hedge against a stock market crash, but you must time it correctly. Despite popular opinion, I'm not fond of gold as an inflation hedge. The inflation rate has jumped 175% over the past three years, and gold has increased by 12%.

Owning a globally diversified portfolio will help you fight inflation and a recession. What is a globally diversified portfolio? It is one where you own US stocks, large companies, small companies, international holdings, bonds, cash, and alternative investments. Some industry experts refer to this as an all-weather portfolio. The portfolio works well because the individual components react to changing market conditions at different times, and it's impossible to time the market or accurately predict inflation or a recession.

To fortify your portfolio, diversify your investments and follow your plan.

The is no such thing as bad weather, only different kinds of good weather. ~ John Ruskin

February 21, 2023

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on your asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren't suitable for every investor. Prices and yields are for today only and are subject to change without notice.