Bonds, not Stocks, Suffer more with Inflation

A few weeks ago, we mentioned in our market update that we are not overly concerned with inflation at this time. The reasons include the massive deleveraging occurring in the U.S., a lack of upward pressure on wages and falling real estate prices, all of which are offsetting increased government spending. However, if the government continues to spend like drunken sailors, there is certainly a risk of inflation down the road. With money market funds now paying close to 0%, many individuals are looking for other investments that have a measure of stability yet provide a higher yield. Bonds are receiving much of this consideration. If inflation does come back in the next few years, this could turn out to be a painful decision. To demonstrate our point, we only need to go back to the late ‘70s when inflation was rampant. Listed below is the price return (excluding dividends and interest) of both stock and bonds from 1977 to 1980. With interest rates and dividend yields currently very low, we believe that if inflation does come back in a similar fashion to the late 70’s, the price return shown below will be a good indicator of what one should expect on their investments.

Many people are surprised that stocks held up well during the inflation infested ‘70s. The reason is that companies are able to raise prices in such time periods and hence earnings tend to keep pace with inflation. It is a built-in hedge against inflation.

We currently do not believe investors are being paid enough to buy longer-term bonds. This is why a majority of our fixed income investments are in shorter-term and higher yielding corporate bonds. This allocation should preserve capital if inflation creeps into the economic picture. We are watching for possible signs of inflation and will make adjustments if we believe they are warranted.

Sincerely,

Your THOR Team