Protecting your portfolio: Is it time to prepare for inflation? (Part 3 of 3)
Without more tangible evidence of a pickup in wages, I’d avoid restructuring a portfolio around expectations of imminent inflation. That said, over the long term, investors should be concerned about preserving purchasing power. Unfortunately, some of the traditional inflation hedges are expensive, despite the dearth of imminent inflation signs.
For example, TIPS are barely providing a positive real yield, even before taking taxes into account. And as I recently discussed, while gold (IAU) and silver (SLV) both have a place in a portfolio, the potential for rising real-rates calls into question whether now is the right time to add to precious metal positions.
Market Realist – Investors often use Treasury inflated-protected securities (TIP) to protect against inflation, since the principal value of the bond moves with the consumer price index. But currently, TIPS don’t seem to be a feasible option, given low yields.
The following graph shows the yields of five-year constant-maturity inflation-indexed securities. The sharp drops don’t paint an encouraging picture.
In contrast, the bond market has been posting high yields. While the iShares Barclays Treasury Inflation Protected Securities Fund (TIP) has given year-to-date returns of a meager 4.9%, the iShares Barclays 20 Year Treasury Bond Fund (TLT) has posted year-to-date returns of 14.65%.
Equities (SPY) seem to be a good investment option. The markets are performing particularly well this year. Due to a rise in geopolitical risks and the U.S. energy renaissance, the energy sector—as tracked by the Energy Select Sector SPDR Fund (XLE)—is in a boom. It’s posting year-to-date returns of 11.84%, making it an attractive investment opportunity.
Instead, I’d look to equities to provide a long-term hedge against an eventual pickup in inflation. In particular, I continue to like energy stocks. Despite outperforming year-to-date, the energy sector is one of the few segments of the market that still appears inexpensive. Finally, the sector has an additional benefit: In the past, energy stocks have been one of the better performers when inflation is rising.
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Investing involves risk, including possible loss of principal.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.
An investment in iShares Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency and its return and yield will fluctuate with market conditions.
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Browse this series on Market Realist:
- Part 1 - Protecting your portfolio: Is it time to prepare for inflation?
- Part 2 - 4 must-know facts about rising inflation and your portfolio