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TCFP70: Inflation

Inflation is very much the silent killer of our financial and, therefore, lifestyle dreams. Inflation should not be underestimated, and it may or may not be back:

Inflation is not back because:

  1. Supply shortages have pushed prices up because companies did not see demand rebounding this soon.
  2. We are ready to spend. There is a lot of pent-up demand.
  3. Things will get back to normal once supply bottlenecks ease and spending returns to normal levels.

Inflation is back to stay because:

  1. Government stimulus might be here to stay which could lead to new higher levels of demand.
  2. Psychology plays a part – maybe prices are higher now because higher prices are expected in the future and that loop continues.

However, we are not in the game of forecasting what the future might bring, so let us stick to what we know.

We know TCFP recognises the importance of inflation. We know our portfolio’s mandate is for growth greater than inflation, after all costs, over a rolling three-year period. We know we have been successful in achieving this.

But will we be going forward? Is the TCFP portfolio well-positioned to continue to beat inflation?


Data Review

 To answer that we need to look at the historical record and review the long-term real returns of the asset classes available to us. Over the last 100+ years, the world has turned upside down any number of times – all those tumultuous events are completely captured in the historical interest rate, inflation and asset return data.

With enough historical data we can be confident that what has happened in the past will happen in the future.

The asset classes available to us are bonds, equities and commodities. We exclude property because there is enough exposure to property via the equities you own. And cash is not included because it is for spending, not accumulating.

These Historical Returns Tables show a summary of after-inflation returns of all the major bond, equity and commodity markets for the last (up to) 200 years. On the first page is a summary, on the second annualised returns covering 1, 5, 10, etc., years.

On the first page we see that equities are more likely than bonds to beat inflation. And even when they do not beat inflation (1972-79), they do not do as badly as bonds. Commodities are a train wreck throughout except for those seven years in the 70s. Very high inflation will be flagged in advance; it will not turn up all of a sudden and, if it does turn up at all, we can react accordingly.

On the second page just about every single period shows equity returns hugely in excess of inflation and healthily in excess of bonds.

In conclusion, out of the three asset classes available, equities have provided robust protection against inflation, bonds are not bad and commodities are usually terrible (except in extremis).


TCFP’s Portfolio

 For these reasons, the TCFP portfolio is 80% equity, 20% bonds. We do not hold bonds for returns, they are in the portfolio so we can take opportunities to buy suddenly cheap equities and/or meet future cash needs.

Every year, almost without fail, the equity markets serve up a juicy opportunity to buy significantly lower. We expect the same this year and we expect to sell some bonds to capture it.

To make your equity exposure “safer” we spread ourselves far and wide – we do not prefer one region, sector or style (value vs growth) over another.

We do make a call between large companies, small companies and emerging markets companies. Currently we favour the latter two. They can be expected to do better than larger companies as the global economic recovery gathers pace. As that pace slows, we will move back towards larger companies.


In Summary

  1. In terms of inflation protection, I believe you are as well-placed as you can be. If inflation seriously gets out of hand, then we will look at commodities.
  2. In the short term, nothing can be known; it might get scarier, it might not. Either way we cannot make investment policy on crystal ball gazing.
  3. In the long term, equities have absolutely blitzed inflation and there is no reason to expect that will not be the case in the future.



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