I’m of the opinion that inflation will be with us for awhile.
With that in mind, I thought I would provide some thoughts on how to invest in such a market climate.
First of all, if inflation remains high, and interest rates remain high, the overall stock market will underperform.
Why?
Because high interest rates increase the cost of debt and capital for corporate America, which will squeeze their profits. It will be much more difficult to make money in this environment compared to the low interest rate environment we experienced from 1995 through 2021.
This is a montly chart of the Dow Industrials from the late 1960’s until the beginning of the 1982 bull market.
In 1972, inflation bottomed out at 3.2%. By 1974 it had risen to 11%, and the market endured a 50% decline. 1972 to 1982 was effectively a lost decade for the stock market as inflation rates ranged from that low of 3.2% in 1972 to a high of 13.6% in 1980.
To finally quell inflation, the Fed was required to raise rates to over 15%. Once it was slayed, and Reagan’s tax cuts kicked in, the market was finally able to take off.
I can easily see a longer term scenario where the Fed fails as it did in the 1970’s, as did government fiscal policy.
How to invest during inflation
If you want to achieve higher rates of return that outpace inflation, you are going to need to actively manage your portfolio.
Simply throwing money at the stock market in general won’t cut it.
From 1970 to 1982, inflation totaled 159% while S&P 500 returns totaled 169%. However, during the decade of the 1970’s General Dynamics stock price rose over 400%.
Many other stocks had periods where they significantly outperformed the market. This is the case in any given year, but it is more important to consider now since it is likely that stock market returns will be mediocre for the foreseeable future.
Therefore, it’s a good idea that you learn how to identify and trade these stocks.
Another area to look into is the commodity markets. During the 1970s, the Goldman Sachs Commodity Index rose at an annual rate of 21%.
The 1970’s gave birth to the managed futures business, as a number of commodity traders experienced substantial returns during that decade and into the 1980’s.
Some of the longest running, most successful commodity trading firms achieved substantial returns through an approach known as trend following.
This allowed them to capture some of the significant moves seen in oil, grain markets and metals during that time period.
Trading is hard
Don’t get me wrong. Active trading is a difficult endeavor, and this is why most people who try it are generally unsuccessful.
Trading requires substantial discipline and an understanding that losing trades are normal, and simply a cost of doing business.
Many people seem to think that successful traders are right far more often than they are wrong, when the reality is some of the most successful traders are have win rates well below 50%.
I’ve put together a couple different guides for trading stocks and trading futures. My goal for each is to substantially reduce your learning curve if you desire to begin actively managing your investments.
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