Inflation has been quiescent the last few years, and the world's monetary authorities are convinced that, in spite of their extreme money printing, it'll stay that way. But we should regard all such predictions with the deepest suspicion and structure our portfolios accordingly.
Specifically, we need to see how sensitive our portfolio is to an upsurge in inflation and select some plays that may neutralize this risk. Fortunately, there are a number of places dividend investors can look if they want their income to keep up with inflation… or even beat it.
Inflation Dead Ahead?
Most income-oriented investments do poorly in an inflationary surge. Therefore, defending against a possible inflation surge is sensible.
At the moment, Friedmanite monetarists would expect U.S. inflation to be running at a fairly substantial clip. In fact, Friedman's theory that inflation is everywhere and is always a monetary phenomenon seems to suggest that inflation is about to accelerate.
M2 money supply has increased 5.6% in the past year, compared to a 4% increase in nominal GDP, and has been increasing faster than nominal GDP since 2009.
The decline in the U.S. unemployment rate towards the “full employment” level of 5% will likely increase wage pressures, as well. And declining oil prices will cause U.S. consumption to increase, putting further pressure on prices generally.
Another concern is that many dividend-oriented investments are derived from companies whose revenue doesn't increase with inflation and may even be adversely affected by it.
Banks, for example, earn their money in nominal dollars and have bond portfolios that will decline in price as inflation rises. mortgage REITs are even more dangerous in an inflationary period, because their income streams decline with short-term rate increases and their asset values decline with increases in long-term rates.
Even business investment companies, which frequently pay high dividends, are generally doing so from an income stream in nominal dollars from bonds and preferred share investments in companies.
