As Inflation Worsens, Buy This Hedge (Hint: It’s NOT Gold)
It’s baaack! After a long period of dormancy, inflation is stirring. However, investors have grown so complacent about inflation, they’re ignoring the recent signs that it once again poses a dire threat to their wealth.
This issue, I discuss the inflationary risks ahead. I also highlight a company with a ubiquitous logo whose services are increasingly popular from coast to coast. You’ll probably be surprised to learn that its stock is a highly effective inflation hedge.
First, I want to flesh out the latest indications that the inflation peril is very real.
To be sure, there’s a doom-and-gloom school of advisors who continually ring the inflation alarm bell, even when inflation is tame. They’re a tiresome bunch with hidden agendas. But as the saying goes, a broken clock is correct twice a day. And now, inflation should actually worry you.
According to new data this week, February’s Producer Price Index came in higher than expected, with producer prices rising 0.3%, above the average analyst expectation of 0.1%. Core producer prices increased 0.3%, versus the consensus expectation of 0.2%.
January’s Consumer Price Index (CPI) also spiked higher, due to a 0.6% monthly increase in “headline” CPI, the figure for overall inflation. Excluding food and energy prices, the monthly CPI gain was 0.3%.
Meanwhile, January retail sales also showed higher prices, jumping 0.4% since December and a troubling 5.6% since January 2016.
Inflation shrinks the real rate of return on investments. If an investment earned 7% over a 12-month period and inflation averaged 1.5% over that time, the investment’s real rate of return would have been 5.5%.
Jim Pearce, chief investment strategist of Personal Finance and director of portfolio strategy of Investing Daily, expresses the rising danger this way:
“Lately, middle-aged Americans have been waxing nostalgic over many things from their youth in the 1980s, but high inflation isn’t one of them. Anyone who experienced that era’s double-digit mortgage loans and escalating prices doesn’t pine for more of the same.
But like it or not, higher inflation is coming, and understanding how to profit and protect yourself from it is how you’ll keep your nest egg safe and growing.”
You need to buy inflation hedges now, before the rest of the crowd realizes the magnitude of the threat and bids up the prices of these assets. As Jim advises:
“Although you can’t prevent higher inflation, you can avoid some of its pain. First, you can adjust your allocations and put more money in hard assets such as oil, metals or real estate, like we did for our portfolios in January, when I raised our exposure to these inflation hedges to 30%.”
Below I focus on real estate, which has long been one of the most effective strategies to preserve wealth during inflationary periods. Whereas investors in the 1960s had to choose between physical real estate and a limited number of real estate investment trusts (REIT), today there’s a wide variety of real estate hedges to choose from.
Real estate historically has outperformed during inflationary periods, but not all modern REITs may perform as well in the future. Some of today’s REITs aren’t totally immune to the effects of inflation, because they can be negatively affected by rising interest rates. If a REIT borrows heavily to finance acquisitions, for instance, it will find its cost of financing rise along with rates.
That said, REITs overall have been excellent at wealth preservation. Let’s take a look at how they fared during periods of exceptional inflation.
Whip Inflation Now…
In 1974, as inflationary fires were raging, President Gerald Ford declared inflation “public enemy number one” in a speech before Congress. He unveiled the “Whip Inflation Now,” or WIN program, designed as a grassroots effort to encourage public and private steps to combat inflation. People who supported the measures were encouraged to wear WIN buttons that were distributed to the public.
The well-meaning WIN campaign was widely derided as ineffectual. In fact, Alan Greenspan, then Chairman of the Council of Economic Advisors, called it “unbelievably stupid.” Sure enough, WIN did nothing to stem inflation. It finally took Fed Chairman Paul Volcker’s draconian interest rate hikes to kill the inflation beast.
Consumer price inflation in the U.S. reached a peak of 13.5% during 1979, the worst inflationary year since 1947. Dividend income from REITs traded through the stock exchange averaged 21.2% that year and total returns amounted to 24.4%, more than preserving for REIT investors the purchasing power that they had lost to inflation.
Inflation averaged 11.6% per year during 1978-1980, the worst three-year period in six decades. Again, however, publicly traded equity REITs outpaced inflation with income and total returns averaging 12.2% and 23.1% per year, respectively.
The period 1974-1981 was the most inflationary eight years in the history of the Consumer Price Index at 9.3% per year, but equity REIT returns easily preserved purchasing power, with income and total returns averaging 10.2% and 16.3% per year.
Among the most successful inflation hedges within the REIT category is self-storage, a property type characterized by short lease terms and therefore frequent lease turnover and renegotiation.
Americans are increasingly nomadic, moving from location to location, in turn fueling demand for storage units.
Orange is the new hedge…
Which brings us to Public Storage (NYSE: PSA), the operator of those orange self-storage warehouses you see everywhere. You probably never thought of PSA as an effective inflation hedge, but think again.
With a market cap of $38 billion, Public Storage is the largest storage company in the U.S. This REIT has an ownership interest in 2,310 U.S.-based self-storage facilities and 220 European storage facilities. The storage spaces are available for lease on a month-to-month basis, for personal and business use.
In the latest sign that demand for its storage spaces is growing, PSA last week opened in Jersey City, NJ a vast storage facility with 3,978 units, the most under one roof at any of the company’s locations.
As the number of Americans selling their homes and storing their belongings skyrockets, Public Storage is the best way to leverage this trend.
For PSA, earnings momentum is in the cards. The average analyst consensus is that PSA’s year-over-year earnings growth will reach 17.3% in the current quarter, 10.6% in the next quarter, 7.9% in the current year, 7.5% next year, and 8.3% over the next five years on an annualized basis. The dividend yield is a robust 3.64%.
Got a question about inflation or REITs? Drop me a line: email@example.com — John Persinos
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