In a world with higher levels of inflation, what investments and strategies will do well and which ones won’t.

Welcome to Finance and Fury. What investments will do well and those that wont in a world with higher levels of inflation

Financial investments – Been talking about MMT and inflation – but what hasn’t been mention – a lot of these intentions of providing business with credit, helicoptered money, ensuring government is financed and QE have had a secondary objective - to support and prop up financial asset and markets – but these policy efforts favour some asset classes over others

Uncertainty and risk

Risk and uncertainty are related but different Risk = speculative/volatility Uncertainty = Unknown risks – generally creates freeze response initially – just don’t do anything – spend or invest Uncertainty creates an environment where people avoid risks but then once they become afraid exit from existing risks In shares – creates selling – not sure what is going to happen – we are loss adverse = sell to avoid losses The important point is 1) have confidence in assets to avoid absolute losses and 2) getting growth to negate inflation – balancing act between taking on risk for reward – but managing the risk to get long term losses Confidence is key – Confidence in any asset is what is needed Why is confidence important? If a lack of confidence/panic is what causes prices on assets to drop heavily – then the solution is to be in assets that while may be impacted in prices (short term volatility) – will not go to zero Asset goes down in value – so what? - Depends on type of asset and what you do, and what those investments are to you Why growth is important – it adds an additional component of returns – Total return is income plus growth – income only assets are normally tied to interest rates – Cash and FI – Say you have cash – getting 1% return – that is interest but no growth – real growth is negative with inflation over a 10 year period – unless interest rates are above inflation Say you have shares – dividend returns (income) of 4% p.a. – this alone puts you above current inflation – but the growth can be positive and negative – longer term – if you get 4% growth – long term total return is 8%

 

Lets look at the asset classes - General information - What assets to avoid

Cash – pretty obvious one – cash is a medium for exchange – not a great asset over the long term – Great in short term – important to have emergency funding – But long term – cash is not the best strategy – this is due to the current low interest rate environment, inflation and monetary policies – money has lost around 98% of its real value since becoming a fiat based system Saying back in my day - $1 could buy you a pair of shoes – cause $1 was worth a lot more – but also – going back in time interest rates were at the same income yield as share dividends are today With constant inflation targets – this has eaten away savings and the real value of cash – but the Bonds – with debt levels going up – and interest rates being low – if inflation kicks in then bad long term assets First - look at how financial assets are valued – A lot of it comes down to debt yields and interest rates in the fiat currency world, the principal asset from which all others take their valuation is government debt – the 10 year US treasury or Bond yields Risk free assets – in risk premiums But these RF returns are almost becoming obsolete - with US Treasury debt yielding less than one per cent for all but the longest maturities (50+ years) - in Europe, Switzerland and Japan - negative rates are common – these models aren’t designed to work out the value of assets if the return on something risk free is negative – as who would buy a guaranteed negative investment? Commercial banks and investment managers are no longer demanding any new debt instruments for new government debt – so central banks across the world have to pick up the slack - are effectively becoming the only significant actors on the buy side for not just government debt, but a wider range of financial assets as well – In the USA - The Fed has already stated it will offer additional support to bond markets by buying ETFs invested in corporate bonds – through SPVs – This puts a floor under bond spreads – so there is an artificial demand to avoid a collapse – but this is reliant on monetary policies – what is they stop one day? Prices of these assets then crash – CBs hope to support everything from junk to investment grade, because if it did not, spreads would blow out even more, threatening bank balance sheets which are thought to carry some $2 trillion of this debt both directly and in collateralised loan obligations. Bonds are no longer really an investment IMO – but become a merger of government and private funding mechanism that has removed the incentives for most investors to invest in debt Upsides are limited – only get additional yields if the default risks rise traditionally – however – now even though default risks are rising – yields haven’t been – as these bonds are being bought up by central banks and artificially lowering the incomes that other investors can get With inflation – and limited yields – and risks of interest rates rising – bonds may not be a great long term investment asset class If inflation kicks in – and interest rates rise in response – then bond values decline and real losses are compounded by the inflation

What assets can do well – ones with real values and with growth or their own inflation in price gains

Alternatives and Growth assets -

Alternatives -

Commodities and precious metals – Silver – and also gold Gold – Has a real value of storage – depending on how much additional money is introduced – a monetary reset will be required – gone for a long time without one – one of the longest periods in modern history Talks that gold will be the backing agent – but I personally don’t think so – based on Central Banks and the IMF – may be more likely to be some form of digital currency or crypto – could have gold backing it – but just as likely to still have some form of Fiat backing it – essentially a stable coin In either case – Gold prices would likely rise due to uncertainty and people seeking a historical safe harbour Silver – GSR – in inflationary times – Silver beats gold – again no guarantees – but in current part of economic cycle – we are deflationary – but when things pick back up and inflation comes back – silver may have a bit of a resurgence – when this happens no idea – but things move in cycles and the next stage of the cycle is likely to be inflationary Check out K wave episode and the one on the GSR if you havent heard this Infrastructure – not really an alternative – but one that people don’t think about that often – But focusing on what people need to use – Infrastructure – hard to get into this directly – but there are MFs and share assets that buy these types of assets – shares that work in infrastructure directly – as the road to recovery that a lot of governments are pointing to is increased spending on infrastructure – money needs to go somewhere

Traditional Growth assets – Property and shares - Reason – need to get capital growth of assets to offset rising inflation

Shares – Solution – Step 1 - Buy good companies, diverse business models, diverse markets and lot of different companies – diversification. Companies with relatively lower debt to peers in group – havent been doing debt fuelled buy backs Step 2 – Don’t panic sell if they go down Alternative option – to get better diversification - Managed Funds/ETFs – Active or passive? High conviction – Active funds – Benchmark unaware - ones that are undervalue through not ETF purchase Why active is important? Contrarian trend – can avoid any overpriced share in the index – even if a company isn’t making money – people buy them and they get into the index – the prices go up for no other reason Good active managers who select smaller number of shares High Conviction - Contrarian to whole index – Goes against the trend of full invested funds in passive – active managers can hold cash for bargains Benchmark unaware - being a large cap manager limits bargains and forces managers to into the top end of an index which will suffer in large passive ETFs/index selloffs - Break up the risk through investing consistently - cash set aside for financial emergencies is important dollar-cost averaging – breaking up cash if holding a lot – or natural form from surplus cash Do it from cashflow - Spend less than you earn – invest the rest – regardless of what your fears or greed Property – Central banks have already supported house prices with interest rate policies – Now some are also buying mortgage debts to avoid drops in demand – these have been in hopes that by preserving a wealth effect, investors will not only continue to feel well off but be encouraged to keep investing – property itself should have some land value going forward – something that supply cant be massively increased in – as land has a natural capped supply – as opposed to apartment blocks that can be put up in the thousands relatively quickly Risk of inflation to rents – rents may not be able to be increased at rates on inflation – menu pricing – increasing rents by 5-10% p.a. is hard eventually to find a tenant – especially with the build to rent scheme and offering of subsidised rents – competitive market Leveraged nature – going forward – if inflation kicks back in and interest rates remain low – may present more of an opportunity for real growth – not nominal Borrowing for investments – could be a strategy that works – this is just an illustration – borrowing to invest can be very risky and not for the faint of heart – The adventurous will borrow fiat to buy growth assets – can be anything – shares, on property, etc. in the expectation the fiat repayment will be very low going forward - the suppression of interest rates by central bankers is likely for some time – so if interest rates stay low – and If inflation kicks back in – it is a double win – Example – Borrow $10k – IO loan at 3.5% - inflation goes up to 4% - and invest in a growth asset that can get you 8% return – over a 10 year period what does this look like Investment value – $21,600 - real value of investment with inflation $14,600 (PV) - then real value of the debt $6,750 Interest you have had to pay - $3,500 - but deductible – assuming inflation – real value of repayment $2,838 Assuming no deduction, including for inflation and interest rates – net value of strategy is $4,990 in 10 years Over 20 years Investment value – $46,610 - real value of investment with inflation $21,272 (PV) - then real value of the debt $4,564 Interest you have had to pay - $7,000 - but deductible – assuming inflation – real value of repayment $4,758 Assuming no deduction, including for inflation and interest rates – net value of strategy is $11,950 in 20 years Lots of assumptions here – but just an example of how the strategy works

Summary – Assets that while not retaining value like you could want (drop in price) – if you hold you can survive

Have a range of investments (not just bank shares) Some physical assets – Gold Shares in companies that people will still use – not fad companies or ones build on people’s discretionary spending – but essential spending and things that the economy and we cannot go without - Property and infrastructure – physical assets – That you can hold and not need to sell Borrowing to invest for the longer term - Make sure they are quality assets Don’t sell – enter market slowly during a panic

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