Inflation, it’s not just for balloons

The COVID pandemic has impacted the global economy in many ways.  Supply chain shortages, stimulus packages, already low-interest rates, and unprecedented government spending have led to an economy that overheated.  Inflation is the natural end result of these changes.  For many investors under the age of 40, inflation has been something often talked about but not experienced.  The historical rate of inflation since 1982 has been below 5% and is usually closer to 2% (see figure 1 and 2).  Although we see inflation as a serious problem, it is only the spark that will light an enormous conflagration.

Figure 1

Figure 2

Policymakers and the Fed have responded by raising interest rates to try and douse an economy that is currently on fire.  The downside impact here will be devastating to a certain group of companies: ones on the margin.   As shown in Figure 3, the rate of corporate debt as a percent of GDP has risen to levels higher than seen in the previous recession in 2008.   As interest rates rise, the financially undisciplined businesses will be unable to refinance their debt at their original rates.

Figure 3

Indeed, China is already seeing some defaults in businesses that were once considered safe.  What does this mean then for your portfolio?  With inflation, sitting in cash will erode your purchasing power.   Many low-quality businesses are starting to go on sale, but the falling knife eventually slices everyone.  So what then?

Figure 4. One of many ways to cope with the current market conditions

As with every market condition, the savvy investor will keep a list of high-quality businesses available in his or her back pocket.  When pennies are raining from the sky, don’t walk out with a ball cap overturned.  Now is the time for the savvy investor to get his ranked list of the best available stocks and check it twice.  Oh and also invest in a wheelbarrow to catch all those pennies.

– Article contributed by Hari Radhakrishnan, MD