Are Stocks Your Best Hedge Against Runaway Inflation?

After being fairly subdued for many years, inflation is suddenly being talked about everywhere. How should you tailor your investment strategy in light of the current U.S. inflation rate of 5.4%?

While financial advisors routinely discuss inflation with clients, it hasn't made much impact until this year.

There's been plenty of chatter about whether current high readings are structural or transitory. Either way, it's a good time to check your portfolio to be sure all your assets are invested properly to avoid inflation eroding your future spending power.

According to a report from the CFA Society, a survey of quant investors at a JPMorgan conference found that 47% of respondents believe commodities are the best inflation hedge. Twenty-seven percent said equities; 10% said rate products such as bonds with low risk of default and Treasury inflation-protected securities; while 17% cited "other."

It's easy to see how commodities could stay ahead of inflation. For example, the awkwardly named GraniteShares Bloomberg Commodity Broad Strategy No K-1 ETF (NYSEARCA: COMB) tracks the Bloomberg commodity index.

Year-to-date, the ETF is up 31.42%, rising along with commodity prices. The fund is invested in 23 commodity futures representing grains, precious metals, livestock and other categories. Its broad exposure is a good representation of how the wider asset class of "commodities" could be an inflation hedge.

In fact, the GraniteShares commodity fund has outperformed the S&P 500 by a wide margin. The SPDR S&P 500 ETF Trust (ASX: SPY) is up 19.52% year-to-date.

The point isn't really that commodities are currently ahead of domestic large-cap equities, despite years of underperformance. The point is that both commodities and domestic equities are good hedges right now, far outpacing the rate of inflation.

Traditionally, equities have been the advisor-recommended inflation hedge. If input costs become higher, as we're seeing across all essentially every industry, businesses can raise prices to minimize the effects of their own higher costs.

Of course, as anybody who's ever taken an econ class knows, there's a point at which consumers or business customers will no longer tolerate price increases, and will seek other alternatives. That could mean a lower-cost provider, manufacturing the item or service themselves, finding a substitute, or foregoing the purchase altogether.

So where does this leave equities as an inflation hedge?

According to the CFA Institute, the average annual inflation rate in the U.S. was 3.4% between 1947 and 2021.

"It only fell below 0% about 15% of the time and only exceeded 10% just 7% of the time. For 57% of the time, it stood between 0% and 5% and between 5% and 10% about 20% of the time," writes the CFA Institute's Nicolas Rabener.

Today's investors aren't accustomed to high inflation, or the damage it's capable of.

To bring home that point, here are the average U.S. inflation rates for the past 20 years.

2020 1.2%

2019 1.8%

2018 2.4%

2017 2.1%

2016 1.3%

2015 0.1%

2014 1.6%

2013 1.5%

2012 2.1%

2011 3.2%

2010 1.6%

2009 -0.4%

2008 3.8%

2007 2.8%

2006 3.2%

2005 3.4%

2004 2.7%

2003 2.3%

2002 1.6%

2001 2.8%

2000 3.4%

For younger investors, the idea of staying the course with a somewhat aggressive equity portfolio is probably still a safe bet, especially given the performance of stocks so far in 2021.

For those with retirement in their sites, upping the commodity exposure is still a good idea, given the continued environment that's pushing prices higher. The bottom line is: Even when the market is pulling back, as it has recently, it's definitely not the time to bail out. Quite the opposite is true: You need exposure to equities and commodities more than ever!