Inflation: What Assets for Your Wealth 2/2

Inflation is clearly the economic theme of 2022. To contain it, Western central banks sharply raised key rates in June. Thus, these institutions mark a break with the post-2008 world. For 14 years and almost continuously, they tried to reduce the price of money until they reached the famous negative indicators in 2015. The fight against the collapse of “substandards” will be at this price.

The Covid crisis of 2020 will only continue this trend. Only the Federal Reserve System (FED, USA) began raising its base rate in 2016 to exceed 2% in 2019, before finally setting it at 0% in early 2020.

On June 16, the Swiss National Bank raised its rate from -0.75% to -0.25%, and the probability that it will cross the 0% mark by the end of 2022 is high. Goodbye, fear of parity with the euro is no longer a topic, monetary equilibrium is back, according to the SNB.

Inflation in the USA and in Europe: the same struggle!

Thus, the new task for the SNB is to contain price growth, which is approaching 3% on an annual basis (the figure for May). And if that “official” 3% seems high to you, keep in mind that inflation in the United States and the Eurozone is rising to 8.6% and 8.1% respectively on an annual basis (also in May)! If you have read This articleyou know my point of view on public figures…

On the Asian side: China and Japan maintain much more attractive rates. China is looking to resume or at least maintain its economic growth, while the Bank of Japan estimates that inflation remains within its 2% target. The reason for this new inflation in a deflationary country is the same as here: imported energy.

Under the sun, Switzerland…

So even if inflation is high, it doesn’t make sense to look at it without other data like unemployment and growth. With unemployment at 2.1% and GDP growth expected by SECO to be 2.8% for the year, Switzerland is well positioned to limit the effects of rising prices. In the first quarter, annual growth reached 4.4%.

If we put aside the yo-yo years of 2020 and 2021, we have to look back to the economic growth before COVID to understand where we came from. Over the five years of 2015-2019, GDP growth averaged only 1.36%. If the expectation of 2.8% for 2022 comes true, it will be 100% better than those five years.

So you can ask for a raise if your industry remains booming and the workforce is tight.

The end of inflation?

Can central banks control inflation on their own? Of course not. And geopolitical news does not provide an opportunity to make predictions. Also, how many predictions are correct? No one saw such a significant increase in the Swiss exchange rate in June.

If central bankers can’t completely contain rising prices, the question becomes how to protect your assets. Which assets seem the most interesting? We started to answer here and I suggest the following below.

Repeat again?

In a previous article, I concluded that the only way to beat inflation is to invest your money. We saw that storage of raw materials paid off during the decade of 1970-1979. In particular, oil and gold provided good protection against inflation.

Inflation aside, we can’t really compare the 1970s to where we are now. Indeed, the West was in stagflation. Inflation was high, economic growth was slow, unemployment was high, and the Fed rate had just dropped from 10.50% in 1969 to 4% in early 1970. The Swiss franc has lost 50% of its purchasing power.

The Yom Kippur War and the associated political backlash exacerbated these factors.

Let’s take a look today at the behavior of stocks and bonds during this period.

US stocks

Our analysis begins with the main index of American stocks: the S&P 500. The 500 largest capitalizations at the time, with General Motors, Exxon Mobil, Ford Motor and General Electric in the lead, showed 97.77 points in 1970 and 103 points in 1979.

Large companies offered a dollar efficiency of 5.35%. Adjusted for the exchange rate of the Swiss franc, the loss for 10 years amounted to -60%! How to hedge against currency fluctuations or invest in your own currency can make sense.

Focus on oil reserves

Another point of conflict between today and the 1970s can be found in the financial condition of the major oil companies. The price of black gold increased 10 times between 1970 and 1980 and 2.5 times in the last 24 months. Who do you think it might benefit from?

I suggest you review the profits of oil companies in 2021, as well as forecasts for the current year. Analysts worldwide expect 2022 to be 100 percent better than the previous year, which has already broken a 15-year record. As in 1973, when Exxon Mobil posted profits 80% higher than in 1972.

Let’s dwell a little on this company, which represents oil exploration and production better than others. As you can see in the chart below, stocks rose by almost 80% between 1970 and 1979. And this despite sharp bearish peaks in 1974 (-45%) and 1978 (-20%). That’s 15 times more than the S&P 500 index over the same period.

2022.07.04.  Exxon chart 1970 - 1979

Exxon Mobil benefited today from the post-Covid-19 recovery, with shares up 48% and 43% in 2021 and early 2022, respectively (as of the end of June 2022). Elsewhere, Valero, the largest oil market in the US, rose 33% and 39%.

Therefore, owning large oil companies looks like a winning choice in a period of inflation, especially against the background of the energy crisis. This is at least true for the US dollar investor. Not very “green” as an observation, even if we have to admit that the reality of our dependence on hydrocarbons is catching up with us.

Swiss stocks?

Return home with a Swiss accommodation, in Swiss francs. According to Pictet, investing your money in the main shares of the country would allow you to partially limit inflation. With an increase slightly above 26%, the erosion of purchasing power will be halved. It’s better than keeping your assets in cash, but it’s not very inspiring.

Reading this data too quickly, one would think that it would be better to invest directly in crude oil and gold. Focusing too much on the short term.

A smart investor will work along two axes. He will initially preserve and rebalance his portfolio over a decade, particularly during market downturns, to reduce the average purchase cost. By doing so, our saver will reap greater returns: Investing during the S&P 500 sell-off in September 1974 (down more than 46% from December 1972) will allow him to realize greater returns when the stock markets rise. A simple monthly savings plan will be enough to materialize this effect.

“The best chance to raise capital is when things are going down.” Warren Buffet

Then he will focus on the investment period. With a long time horizon, a smart investor will keep his portfolio well past 1979. Aged 30 in 1970, he will be 60 in 2000. On that day, the Pictet index traded at 53,797 points, or 1,648% better than in 1970 (a factor of 17 for comparison with a multiple of 2.5 inflation).

Sure, our saver would dip into his assets one year or another to buy a house, pay off debt, or fulfill his desires…but inflation would be largely offset.

Swiss bonds

For Swiss bonds, again based on the Pictet study, bond returns exceeded stock returns by 3.5 times over the period 1970-1979. In that short period, that’s great because inflation is eliminated and the real return (adjusted for inflation) is almost 30%.

The result, however, is very disappointing for the period 1970-2000: “only” 429%, which compares with the performance of stocks of 1648% or inflation of 378%. You can find a summary of indices, inflation and exchange rates below.

2022.07.04. Inflation indices Course

Briefly about real estate

I can’t end this article without mentioning real estate. Investing in stone can provide some protection against inflation as rents are usually indexed. An increase in rent theoretically leads to an increase in the value of land.

However, it is worth paying attention to how quickly mortgage rates are rising. The rapid growth of these costs cannot be immediately transferred to the tenant.

During the last major real estate crisis in Switzerland, mortgage rates quadrupled in two years. As I write this text (June 2022), the price of long-term debt (10 to 15 years) has already tripled in a year and a half.

As for the investor favorite rate, SARON (ex-Libor), it may soon rise once the SNB’s key rate goes above 0%, which is expected in late 2022.

Ultimately, even with increased rents, property values ​​may fall (-20% to -40% in the 1990s) and require margin calls (early repayment) from lenders.

In another article, I’ll discuss the strategies and considerations to use to protect against rising mortgages and falling land prices.