How Are We Positioned for High Inflation?
June 10, 2022
Today’s CPI print came in above expectations at 8.6% year on year, which is the highest rate of inflation we’ve seen in America since 1981.
Excluding food and energy, the rate of inflation decreased slightly from last month. Prices increased for food/groceries (+12%), rent (+5.5%), gas, and for other goods including cars, clothes and homeware. We are also seeing inflation spread from goods into services (services inflation is typically stickier than goods inflation). While it’s possible that the rate of inflation will begin to fall (as it did in April before rising again in May), we think that the level of inflation is likely to remain high this year and that the fed will attempt to bring it down by increasing interest rates in a fairly aggressive way.
How Are We Responding?
In May we mentioned that we bought an ‘Absolute Note’ that acts as a hedge against the S&P500. This month we bought another Absolute Note as a hedge in our equity tilt strategy. So long as the issuing bank remains solvent, this absolute note will protect investors by 10% on the downside if the S&P500 falls by more than 10%, no matter how far it falls. It will generate a positive return so long as the S&P500 is not down by more than 10%. We ‘pay’ for that hedge by capping upside on the investment at 5% over a six-month period if the market is up.
We have continued to increase our position sizes in quality high dividend stocks with defensive characteristics at what we view as attractive valuations. Investors have seen that shift in their portfolios, and we think that such positioning is prudent for the foreseeable future.
We are exploring a further allocation to commodities that we believe are well positioned in an inflationary environment. We already own a commodities ETF, which has performed well so far through this period.
We are continuing to price yield notes with terms that we view as attractive. For example, we recently traded a three-year yield note with 40% principal protection on the S&P500, Nasdaq and Russell 2000 and a 10.15% yield.
We’ve increased asset allocation towards pre-IPO companies, which are not subject to daily volatility unlike their publicly traded counterparts. Over the next year, investors will see a steady increase in their investments in private companies as we make new deals.
Overall
With inflation at its highest rate in 40 years, cash is losing 8.6% of its purchasing power per annum. Furthermore, high inflation is driving real wages lower, which increases the chance of a recession in our view. As a result, we have positioned our portfolios more defensively with a relative overweight to value and a higher allocation to alternative and private investments with the goal of reducing portfolio volatility and optimizing risk adjusted, inflation adjusted returns. Quality US companies with strong fundamentals and real profits remain a staple in our investment portfolios. As we’ve said before, attempting to time the market usually results in realized losses and lost potential gains, and we are making tactical decisions without trying to time the market by moving portfolios into cash.
Disclaimer
The information presented should not be considered personalized investment, financial, legal, or tax advice. This notification is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein. Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, and are based primarily on assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed. Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change. Past performance is not indicative of future performance. Principal value and investment return will fluctuate. There are no implied guarantees or assurances that the target returns will be achieved, or objectives will be met. Future returns may differ significantly from past returns due to many different factors. Investments involve risk and the possibility of loss of principal. The values and performance numbers represented in this report reflect management fees. The values used in this report were obtained from sources believed to be reliable. Performance numbers were calculated by Black Diamond using the data provided by your custodian. Please consult your custodial statements for an official record of value.
The securities involve risks not associated with an investment in ordinary debt securities. Selected Risks Associated with any of these structures include: - Notes are not principal protected and investors can lose some or all their initial principal if the underlying asset falls below the Principal Barrier Level. - Contingent coupon payments. Investors may not receive periodic interest payments if the performance of the underlying asset falls below the Coupon Barrier Level. It is possible that investors will not receive any coupon payments over the life of the Note. - Potential for early redemption and reinvestment risk. Notes will be automatically called if the performance of the underlying asset is at or above the Initial Strike Price on the defined Observation Date. If called, investors may not be able to reinvest their proceeds in a product with a comparable coupon. - Returns are limited to the coupon payments, if any. Investors will not participate in any price appreciation of the underlying asset. Additionally, investors will not receive dividend payments generated by the underlying asset. - Limited secondary market. Notes should be considered buy-and-hold investments and investors should hold them to maturity. They are not traded on an exchange and there may be little to no secondary market available. - Issuer credit risk. Notes are senior, unsecured debt obligations of the issuer and all payments of income and principal are therefore subject to the creditworthiness of the issuer. - Complex investments. Notes may have complex features and may not be suitable for all investors.