We can help you add inflation sensitive investments to your portfolio

As independent investment advisors we feel that all of our clients are entitled to customized advice, tailored specifically to their individual situations, investing goals and risk tolerances. One of the benefits of being independent is that we are free to consider among the thousands of investment alternatives available.We weigh the merits of each investment recommending investments only because they will contribute to the success of your investment strategy. There is no pressure, and no incentive, to sell you proprietary products. We then help you track the progress of your portfolio toward the financial goals you’ve set, and advise you when it is appropriate to make changes.

The Importance of Asset Location in Retirement Income Planning

On March 18, 2009, the Federal Reserve dropped a surprise announcement that exploded across financial markets around the world In a release of Federal Open Market Committee (FOMC) minutes, the Fed announced that it would purchase an additional $750 billon of agency mortgagebacked securities and buy $300 billion of longer-term Treasury securities over the next six months. Within seconds of the announcement, every inflation sensitive investment in the world soared in value. The truest barometer of hyperinflation sentiment, the price of gold, increased by more than $40 an ounce. The dollar dropped sharply against all major currencies, the price of crude oil spiked above $50 a barrel, and commodities from food to copper rallied impressively. While the Fed’s announcement was not expected by most economists, it could have been anticipated. Months earlier, the Fed embarked on an unprecedented experiment to use all stimulus measures in its power to revive a sinking economy and reverse an epic recession. In the meantime, the Fed had been joined in its fiscal pump-priming efforts by the U.S. Treasury, two Presidential Administrations, and most other leading central banks and governments around the world. Never in world history has so much new money been created and public debt expanded so fast. March 18, 2009 served as confirmation that the “stimulus era” is far from over. Given this new reality, what can you do to protect your assets?

One answer is to add an “antiinflation” asset class to asset allocation disciplines. Fortunately, thanks to the growth of innovative ETFs, there are more attractive options available for this class than ever before. The combination of several such ETFs (and certain mutual funds) can help to further diversify portfolios while giving clients protection against a probable era of sharply higher inflation ahead.

What Kind of Inflation?

Although the term “hyperinflation” is mentioned often by the media lately, it is probably an exaggeration for the U.S. economy. Typical prerequisites for hyperinflation include collapsing
currencies, political instability, and price rises of 50% or more in a short period of time. The annual increase in the U.S. Consumer Price Index for All Urban Consumers (CPI-U) has averaged 3.9%

over the last 30 years and 2.5% over the last 15 years. Against this backdrop of price stability, sharply elevated increases in the costs of living may feel like hyperinflation to some people, especially retired clients living on fixed incomes. For portfolio planning purposes, let’s consider (as a baseline scenario) an interval in which the CPI-U increases by about 40-50% over a five-year period – representing an average annual increase of about 7-9% per year. We therefore suggest a “model” anti-inflation asset class that might be expected to perform fairly well in such an environment. A related question is whether you can count on the CPI-U to accurately reflect personal cost-of-living increases. The answer is – absolutely not. The CPI-U was invented by (and controlled by) the federal government. As long as Social Security payments are adjusted for CPI inflation dollar-for-dollar, as they are now, the U.S. Government has a vested interest in maintaining a conservative CPI-U. John W illiams’ Shadow Government Statistics argues that as a result of changes in the CPI-U methodology introduces in the early 1990s, CPI-U has understated true U.S. inflation by up to 7% annually. He further argues that the government already intends to replace CPI-U with a more conservative measure of inflation (C -CPI-U) that under-reports inflation by .4% per year compared to the current measure. Here is one key point: Even if you could find a reliable way to tie your retirement incomes or returns to CPI-U, it isn’t enough. A true “anti-inflation” asset class should give you exposure to the “real deal” – the goods you buy to support your lifestyle at future prices.

A second key point: As we saw in 2008 with energy prices, individual commodities can rise and fall dramatically in a short period of time. A solid anti-inflation class should be diversified among different types of funds including precious metals, currencies, energy, commodities, and bonds.

And a third: There are different types of inflation, and it helps to have an understanding of the type that may emerge in the U.S. economy. For example, one type is produced just after the trough of a recession, when a classic V-shaped rebound produces a spike in demand without a corresponding increase in the production of goods and services. Another type occurs when wars, natural disasters, and political instability greatly reduce the supply of goods and services.

These will not be the drivers of the next U.S. inflation wave. To understand what may push inflation, consider what agendas the Obama Administration and Federal Reserve are already promoting: 1) reduction of crushing public and private debt burdens; 2) revival of U.S. output, especially through domestic manufacturing and exports; and 3) higher asset prices, especially in residential and commercial real estate and the stock market. Across economic history, there has been one proven way to promote such an agenda: currency devaluation.

Three leading indicators of currency devaluation are all flashing confirmation: 1) the size and quality of the Fed’s balance sheet, which stands behind the repayment of every dollar floating around the world; 2) the federal budget deficit, which the Congressional Budget Office now projects will be $9.3 trillion cumulatively over the next decade; and 3) the price of gold. Of course, the devaluation of the U.S. dollar won’t be as dramatic as it has been in some third-world countries because of the size and strength of the U.S. economy, the dollar’s status as a reserve global currency, and the ability of the Fed and Treasury to gradually talk the dollar down over time.