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Inflation Type Investment Strategies
By Jeff Neal, Optionetics.com
6/2/2004 6:30:00 AM

http://www.optionetics.com/articles/article_full.asp?idNo=10490

With inflation becoming a growing concern and with oil prices surging, this might be a good time to discuss investment strategies to accommodate each type of inflationary environment. The types of inflationary environments include price stability, moderate inflation, accelerating inflation, and rapid inflation. Each type of inflation demands its own unique set of investment strategies to be successful.

In an economic environment of price stability interest rates will be stable with inflation coming in at the 1 to 3 percent range. In addition, unemployment will be low or declining and the Gross Domestic Product will be growing at a moderate clip. Some investments to consider are stocks and bonds, which generally provide a higher return than the inflation rate. Both growth stocks and blue chip equities are fine choices in this type of environment. However, money market type investments that are tied to interest rates will more often than not perform poorly. Also, real estate can be a good investment since interest rates are relatively low.

Another type of economic environment a trader needs to be aware of is moderate inflation. As the business cycle matures, inflation begins to heat up slightly. The inflation rate is usually being reported between 4 and 5 percent on an annual basis. Usually the stock market begins to level off or show signs of weakness. At this time money market rates and intermediate-term CDs will begin to look attractive. Since inflation could go either way, depending on the actions of the Federal Reserve and market forces, it is not wise to stake out any long-term positions yet. For example, if inflation continues to rise, being locked into long-term CDs could cost you money as rates surge past your guarantee. On the other hand, if inflation moderates, you’ll want to have funds available for other investments. Also, if you do not have a position in real estate yet, then this usually is the last chance to do it before the roller coaster begins.

The next level is accelerating inflation. In this environment the inflation rate is between 6 to 8 percent and requires the investor to start taking defensive positions. This type of inflation is usually a precursor to bad times ahead. By taking defensive positions and you’re wrong, you still have your capital; however, if inflation gets out of hand and you haven’t prepared for it, you risk losing everything.

Money market accounts and CDs are definite components of your portfolio at this time, but you don’t want to lock in rates for too long. An investor should also consider purchasing precious metals such as gold and silver during this period. There is a distinct chance that you will not be able to keep up with rising interest rates and metals will begin to appreciate faster than rates are rising.

Concentrate on blue chip stocks in this environment since they have probably declined in price and are offering some very attractive yields. However, the investor should avoid growth type equities because historically they perform poorly at this point in the cycle. In addition, with the high interest rates an investor should not consider real estate at this time.

Finally, an investor has to be prepared for a rapid or hyperinflation climate. This comes when inflation exceeds the 9 percent level. An investor needs to only be in precious metals and money market type funds. The equities market is usually engaged in a major sell-off so until things start to stabilize the investor should not be purchasing stocks.

As investors we need to be in tune with the current economic environment so we can align our investment objectives appropriately. Of course, if you are an Optionetics trader you already are well aware that you can be profitable in the stock market regardless of the current economic climate.

Happy Trading.


Jeff Neal
Staff Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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