Inflation Protection: The worst is yet to come

Posted March 12, 2008

"Credit market liquidity is a major issue, no doubt, but soaring oil prices, a weakening dollar, falling employment, and rip-roaring inflation are the wolves tearing at this economy’s jugular. " – Andrew Snyder

By Andrew Snyder

Baltimore (TFN) — Do not be fooled into believing yesterday’s super-rally is a sign of good things to come. Tragically, the Fed’s move was one of desperation, confusion, and fear. I heard one financial commentator saying, "Mark the date. This is the day the markets turnaround." I would say he is about to lose a lot of money, but with comments like that, he probably already lost it all.

Credit market liquidity is a major issue, no doubt, but soaring oil prices, a weakening dollar, falling employment, and rip-roaring inflation are the wolves tearing at this economy’s jugular. Add in the damage already done by the sub-prime debacle and this nation has some serious problems gnawing on its throat.

But quite frankly, the booming economy we witnessed over the last few years had little to do with fundamentally sound economics. It was about nothing more than consumer sentiment. The average American believed the economy was sound, so he spent money on frivolous non-essentials, went on vacations, and built a big, expensive new home that some mortgage salesmen told him he could afford.

The hangover is just setting in

The glory days are over. Consumer sentiment has plunged and the average Joe is downright scared. The mechanic tuning your motor or the carpenter building your house does not care the Fed essentially pumped $10 billion of liquid cash into the market yesterday. They don’t care if it costs $1.55 to buy a Euro. And they especially don’t care if the health insurance industry is in the dumps.

The average American is concerned why the cost of everything he buys is soaring, from gasoline to postage stamps to grocery-store lettuce. Unfortunately, Bernanke and his troops are doing nothing to prevent further inflation. In fact, by dropping interest rates and flooding the market with cash, they are increasing it. A very dangerous snowball is beginning to build.

So what are your options as an investor?

Historically, equities were a strong bet during high inflationary periods. As the value of a dollar decreased, shares of companies increased to make up the difference. That is not the case this time around. Inflation is not on the rise because money is easy to come by. It is soaring because of international forces beyond our control… chiefly oil. Companies are being slammed just as hard as you and I.

Shorts lose, longs lose… you win

Fortunately, with the market making daily surges, corrections, and plunges, there are still plenty of profit opportunities in the equities market. Short sellers are tucking into nearly every market nook and cranny. Yesterday’s explosive rally — created mainly because of short covering — is a perfect example of the amount of investors holding (and banking on) a negative sentiment.

If you want a simple, yet highly secure, vehicle to ensure your hard-earned cash continues to work in your favor, you need to boost your supply of inflation-protected investments. Treasury Inflation-Protected Securities (TIPS) are rarely sexy investments that make their way into the headlines, but in a time like this, they are the backbone of any successful investor’s portfolio. If you are not increasing their strength in your portfolio, you need to do it now.

Series I Bonds are another similar option that offer protection from inflation, but most experts agree the liquid nature of TIPS (they can be sold on the secondary market) and their semi-annual payouts (I Bonds pay only upon redemption) make them the better choice for active investors. You can buy TIPS now and dump them when the equities market decides what it wants to do. It is just as safe as burying a bucket of cash under an old oak tree, but TIPS will ensure inflation doesn’t erase your earnings.

There is no debate. Wall Street is in a mess. The Fed is doing its best to help its buddies in the banking industry. Meanwhile, the rest of the economy is showing signs that the damage has spread far faster than most economists predicted. It is too late for the Fed to stop the damage.

Do not be fooled by short-lived rallies. So far, none of them have had the claws to continue their steep climb and most are eventually negated as traders digest the widespread ramifications of the news and data hitting the Street. Cheap money is not always good, especially for a country with a currency few folks want.

There is an old saying in the maritime industry, "Any port in a storm." There is a storm brewing on Wall Street. Now’s the time to head to safety. It doesn’t matter what it is.