Inflation is a lot like the weather. There inevitably will be storms at some point, but no one can predict very far in advance exactly when or how severe.
Some experts are convinced that a rise in prices will be the end product of stimulus packages, bank bailouts, budget deficits, and economic recovery.
Their belief is not universal, and timetables are pure conjecture. Nonetheless, that hypothesis is worth some consideration by any investor with a well-rounded portfolio.
Inflation is not entirely bad if its entrance coincides with some positives.
"If inflation comes, it is the final sign that recession is ending," says James Hardesty, president and chief economist for Hardesty Capital Management, in Baltimore. "So breathe easy, because employment will be improving and things will be getting better."
Should results of the stimulus program kick in at the same time the economy is coming back on its own, it would signal the time to "double the watch on deck" for inflation, Hardesty says.
"The bright side of inflation is that it means stocks are going to do well," says Tyler Bartlett, a financial advisor with Merriman Inc., in Seattle. "The reality is that today's stock market has already factored inflation into its pricing anyway."
From a psychological standpoint, Bartlett acknowledges, bailouts and "the printing of money" that's taken place have many investors fearful of rampant inflation around the bend. But like the weather, inflation can come in different forms.
"The inflation we're likely to see next will be commodity-based rather than the wage inflation we saw in the 1970s," predicts John Derrick, director of research for U.S. Global Investors, in San Antonio. "Even though the next inflation will be a different animal, the type of investments that protected investors in the past, such as copper or energy, will work again in the future."
Hard assets such as metals excel in periods of rising inflation.
Mining company Freeport McMoRan Copper and Gold Inc. (FCX), whose copper used in electrical motors and transmission equipment will be instrumental in building infrastructure in China and other developing nations, is a stock recommended by Derrick and Hardesty. This well-run company has handled both good and bad times effectively. It cut its capital spending budget earlier this year, but has since seen a revival in prices of copper and in demand.
Energy prices are likely to increase when economies heat up.
Petrobras (PBR), Brazil's state-owned oil company, whose latest find is a vast offshore oil discovery with an estimated 8 billion barrels, is a stock recommended by Derrick and Hardesty. This well-managed firm is considered a safe long-term investment, even though money and time will be required to develop that major find. The large number of exploration discoveries it has amassed means its profit increases likely will lead the world's oil industry.
From 1941 to 1947, when inflation averaged 7.5 percent, the top-performing stock segments were U.S. small-cap value stocks, up 28 percent; micro-cap stocks, up 22 percent; and large value stocks, up 17 percent, says Bartlett. It's not unreasonable to expect similar results in a brand-new era, he says.
To survive inflation effectively, he therefore recommends the exchange-traded funds Vanguard Small Cap Value (VBR), iShares Russell Microcap Index (IWC), and Vanguard Value ETF (VTV). Exchange-traded funds, or ETFs, are traded on exchanges just like stocks.
On the bond side, Treasury Inflation Protected Securities (TIPS), which pay a steady yield and adjust to the U.S. Consumer Price Index, are a worthy choice that can take care of an investor's inflation worries effectively, Bartlett says.
The first stocks Hardesty would buy in inflationary times are the steel stocks U.S. Steel Corp. (X) and Nucor Corp. (NUE). He says U.S. Steel has done an outstanding job of "cleaning itself up" the past 25 years to stay competitive while many traditional rivals failed. Steel exports from the U.S. to China will be a significant plus.
"We're going to have a big recovery in automobile sales," predicts Hardesty. "When you're scrapping 13 million cars and building less than 10 million cars, you're running off your automobile stock at a pretty good rate."
Pick the "best of the breed" in car companies, which Hardesty considers to be Ford Motor Co. (F). It will benefit the most from an automotive revival because it has repositioned itself well during the downturn.
"Pushing dirt is a good late-economic-cycle business that benefits from inflation," says Hardesty, recommending Caterpillar Inc. (CAT) because it has a long history of prospering in expanding economies. "The treasurers of those companies don't spend money until they have it in hand, and don't simply make bets about things getting better."
Returning to energy, oil exploration companies will be make major gains as energy prices begin to rise, Hardesty believes. His favorite exploration stocks are Schlumberger Ltd. (SLB) and the offshore drilling company Transocean Ltd. (RIG).
Hardesty doesn't expect inflation to become a more serious worry until the second half of next year, when the economy has made a comeback. Derrick believes investors were fretting more about inflation earlier this year. Bartlett warns against making any sudden and dramatic portfolio changes.
But, as with the weather, when it comes to inflation you just never really know.
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