Tom Discussed Investing During Inflationary Periods
Transcript:
Easan Arulanantham:
So some current news is on inflation came out higher than expected, you know, what kind of investments do well during a high inflation period?
Tom Vaughan:
Okay, good. Well, that’s obviously a topical question. This week, as most of you probably know, they reported the CPI, the Consumer Price Index, which was up 4.2% versus the same time last year, and which is a really big number, that’s a huge inflationary number for the US anyway. Now, the year over year comparison is a little bit skewed, because last year, basically, in April, you know, things were down. And Matter of fact, prices were, you know, struggling to, to stay at the same level. And so but if you look at month over month, so March versus April, actually had depending on what portion of the you look at, but it’s up about point 9%. And so that’s a big deal, too, that’s a big jump from a one month period. And so we’re seeing, you know, all of these different issues that are coming in creating these problems. And most of it is kind of concentrated in certain areas, like used cars, and travel, and hotels and those types of things. It’s a very basic concept, you got people that are willing to come out of the shelter in place at a faster rate that businesses have been able to keep up, and you have employees that are actually reluctant to come back into the workplace for a variety of different reasons.
So how do you invest? And that is basically the question. So let me share my screen. And I can kind of show you, you know, our current portfolio, and when what I think we should be looking at, and so this is our traditional model, we have two different models, we have a traditional investment model. And then we have an environmental, social and governance model, I’ll use this one just to kind of highlight, there’s this is the stock portion, I’ll show you the bond portion in a minute. And I have kind of an equal weight concept here. 15 different pieces all together as what I’ve got in the portfolio at the moment. And so basically, I always start with, you know, the total stock market index. So this is Vanguards version of basically buying the entire US market. And so there’s roughly 3,600 stocks in here. And then we just kind of add to that. So here’s the S&P 500. Right, already in this particular piece of the portfolio, but the S&P 500 is very popular, neither of which is a particularly, you know, spectacular arena for higher inflation, but you don’t know what’s going to happen. And so I always like to have some of the broad market pieces in there. And then this company Invesco has three pieces here. They’re called pure value, S&P 500, S&P midcap 400 and S&P small cap 600. And what they’re doing is they’re taking the S&P indexes.
So this S&P 500 is the same index, but they’re just carving out the value stocks, the heavy value stocks. And what we’ve seen is that in times of higher inflation, value, stocks tend to kind of really do better. And they’re usually they’re higher inflation is coming because we have an economy that’s growing quite quickly. And these value stocks are more sensitive to economic growth, which means that they hopefully will make more during that period of time. So I really like these so far, I’ve been pretty pleased with those, then I have two more value factors. And so what they’re doing here is they’re applying screens, to the overall market to find what they feel is the best value. One is I shares which is managed by BlackRock and the other is Vanguards Wellington, which is a Wellington is a fairly famous old line value fund manager. And both of these are really exciting to me. And then I have two infrastructure pieces. So again, these aren’t particularly areas that might do spectacular and higher inflation. But there is a big push towards infrastructure because of what’s happening politically in terms of the American jobs plan. This is a traditional infrastructure, this is more of a technology side of infrastructure. But here materials we have Vanguards materials, so this bankcard kind of buys all the different material companies. And then here Invesco is taking just the material companies out of the S&P 500 and then weighting them equally.
Most of the times you’re waiting things based on the market capitalization, which is what happens here. So theoretically, materials are going up in price in an inflationary environment, which makes these companies that are making copper and lumber and, you know, those types of things that make more money during that period of time. So that’s, that’s a good inflation hedge. Then consumer discretionary. Again, this is just a play on the reopening as as as people start to spend more, I saw a presentation today and they said that Americans savings rates currently at 15%, which comes out to about $6 trillion, a year of savings. If you compare that to where it was, you know, even before the pandemic, it was about less than 1 trillion. So lots of money that can come out that I think will come into different types of places. banking is a great hedge against inflation, they do better when interest rates go up, transportation is going to move here, because people are moving and things are moving at a faster rate. And then exponential technology actually is just my one overall technology piece here. And that’s not so much an inflation play. But it is a play for when the growth side of the equation takes off, which is today, actually, so these, these two pieces are more growth there. And they actually are doing really well right now today as we’ve had a great run in the NASDAQ today. So, you know, you want to have different pieces in there. But we’re definitely geared towards this value, really inflation play as far as that goes. And that that’s, that’s my outlook for the stock piece as far as that goes.
Easan Arulanantham:
So before we jump over from stocks to bonds, could you explain the difference between like an equal weight fund versus a market cap based fund?
Tom Vaughan:
Yeah, that’s actually a pretty good question. Because, you know, if you look at, say, the S&P 500, it’s market cap weighted, which just means that a company like Apple is going to have a lot more impact on that particular index than a smaller company would. Matter of fact, the top five companies in their five or six make up a lot of the movement of the S&P 500. So sometimes you want to get representation in some of those smaller mid sized companies. So if you use equal weight, that just says, Alright, we’re just going to say, Here’s 60, companies, we’re going to buy the same percentage of all of them. And it gives you a better exposure to some of those smaller mid sized companies that are in that particular index. I like both. And there’s lots of different ways to weight these indexes. They can weight them on revenue, they can weight them on dividends. And so the weighting is something you really have to understand. So you can see what’s going on within those. And I do I have two equal weight pieces in here that I happen to like, as far as that goes, but I like that mixture, too. I like to have both, you know, market cap weighted and equal weight in that same portfolio. So yeah, that’s a good question.
Alright, so and then the other piece is the bond side, which I’ll show here real quickly, because this is actually more difficult. This is our current traditional model, with just the 100% bond. So bonds do very poorly in an inflationary environment, because when inflation goes up, that drives the yields of bonds up, which means that the price of the bonds are going down, and the price generally goes down faster than the yield comes up. So you can lose money in the bond market in this particular environment. So there’s a couple of ways to try to hedge that or strategize around that number one is to stay very short term with your bonds. And that just means that they don’t move up and down in terms of the price as much as something that’s longer term. And so here, for example, you know, we got short term government with Vanguard short term tips, this has actually been doing very well. A tip is a treasury inflation protection security. These are designed by at by the Treasury to do better in an inflationary environment. And basically, what happens is the yield moves up with inflation. So that protects the price. And then high yield is an area that in in an improving market, high yield does better.
But if you go with a shorter term, high yield, there’s some questions about how this works. But you are insulated, somewhat by a higher yield as far as that goes, too. So that helps. And then I have two that are inverse, that means they go the opposite direction, the bond market. So in the bond market falls, these might go up. And so I have one, that’s a seven to 10 year Treasury inverse, and another one that’s a 20 plus year Treasury inverse. So for example, you know, Monday, Tuesday, Wednesday, when the market was falling apart, and bond yields are going up, these were actually and you know, bonds itself were going down, because yields are going up, it’s an inverse relationship. But these went up. And so that’s why those are in there as far as that goes. And then, you know, you can see the mix. So here’s a 60% portfolios, I got 40%, you know, in the bond pieces, and 60% in those 15, you know, stock pieces.
So that’s, you know, this is actually our most common portfolios, a 6040 mixture. So, anyway, that’s the that’s what I would be looking at in terms of trying to fight inflation, in my opinion, really trying to make sure that you have pieces in the portfolio that have you know, less sensitivity to rising interest rates. So your big tech stocks might do okay, just because you know, for example, Apple reported a 54% increase in revenues in there, which is an unbelievable number for a big company. But your other tech stocks are exponential, you know, your your tech stocks that are like, what we see in the ark funds, for example, innovative technology, clean energy genomics, those all ran up so much, when interest rates go up, they tend to really suffer. So you definitely want to rotate, in my opinion, somewhat out of those, maybe not completely, but somewhat out of those and towards these economically sensitive kind of value stocks, transportation, materials, financials, energy, you know, those types of things are things historically, that have done better in in this particular type of market. So we’ll see how that plays out.