Is inflation coming? – You better have a plan

The debate about potential inflation around the corner has been around for a while. Either inflation or deflation theories have their renowned supporters. Let’s have a look at the current situation to understand repercussion about how Central Banks are acting. It may help to realize the dimensions of the problem and how it affects the retail investors.

The increase in Money Supply by Central Banks

Because of the unprecedented shock in the economy caused by the pandemic, Central Banks have been printing money since March-20. This money helps governments to pay for furlough schemes among others. It has made that the amount of money has increased considerably in the last months.

Money Supply 2021
Source: Andrew Nyquist

So why if Central Banks have been printing money for the last 10 months there is still no clue about inflation? Well, there are also many deflationary forces in the system. Some of the are hopefully temporal such as unemployment and weak economic activity, but others are structural such as technology and demographics. All these forces are reducing considerably the velocity of money. However, we are now to focus on the first two as they are a consequence of COVID-19. The other two are the reason why inflation in the last decade has been much smaller than it was in the ‘70s and ‘80s.

The velocity of money is described as the number of times that the money changes of hands. Basically, it means that if there is a lot of new money, but people do not spend it, the prices are not going up as there is not an increment of demand for the goods. Consequently, to have inflation, we need people spending their money. So far, because of the lockdowns, rising rates of unemployment and fear of the situation in the coming months, it has not happened.

Money Supply, Velocity and Inflation 2021
Source: Andrew Nyquist

As it is shown in the graph above, the amount of money printed by the FED is double that it was in the financial crisis (2008). This is already having massive consequences in the stock markets. Bubble debates apart have been increasing its All-Time-Highs since the arrival of stimulus packages & vaccines. The FED is transmitting the message to investors that no matters how bad the situation is. It will continue printing money to solve all the problems. Obviously, this monetary policy is not solving the problems but delaying them. And potentially making them bigger and riskier to solve in the future.

It is noteworthy to remember that the current deflation is the enemy of government debt. As it makes their debt more expensive to pay. On the contrary, for savers (people like you and me), inflation is the real enemy. It destroys the value of the money.

What are the implications of higher inflation?

The implications are enormous. Investors should be mindful of the situation to adapt its portfolios to this scenario. As Ray Dalio says every time he is interviewed, in this potential scenario cash would be trash. Along with fixed income and credit. Instead of owning those deflationary assets, a portfolio should be compounded by Equities, Commodities and Real Estate. Unluckily, the construction of this portfolio would not be easy work at all. After 10 months/years of a bull market, there are sectors or even new asset classes like cryptocurrencies meeting all the criteria to be considered to be in a bubble. 

Our takeaway in this situation is the importance of understanding the current scenario. It is a must to analyse the potential outcomes and be ready to place your assets following a plan. We believe that the coming inflation is a fact, probably in a matter of 6-18 months as the vaccines start immunising populations*, so we are acting to minimise the potential damage. In spite of the high prices registered in the stock markets in the last months, we maintain a high exposure to equities. However, we are also pivoting to REITs and other asset classes. At the same time, we are balancing 40-60% our Growth vs Value equity portfolio.

*If vaccines do not tackle the problem, it would be and absolutely different scenario, and we also need to have a plan for it.

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