Prepare Your Portfolio Now
Fed Chairman Ben Bernanke and the Federal Reserve decided to set sail with QE2 — or a second round of “quantitative easing” policies, for those more aware of the famous ocean liner than economic jargon.
In layman’s terms, quantitative easing is a monetary policy used by central banks to stimulate the economy by increasing the supply of money in the system and increasing the excess reserves of banks. Or in more pejorative terms, the Fed is printing more money to satisfy Washington’s runaway spending and hopefully prop up an ailing economy.
I’ll leave the merits and menaces of QE2 — and the nautical puns — up to those on the rest of the Internet. The bottom line is that regardless of whether another round of quantitative easing is a success or failure, the result will be the eventual rise of inflation and devaluation of the dollar.
To help investors prepare their portfolios, here’s a 10-step inflation survival guide.
1. Get Rid of Your Cash
This may be hard for many risk-averse investors to do, but the bottom line is that during periods of rapid inflation, your money is literally worth more today than it will be tomorrow. So “spend” it. Whether that means buying a car now instead of next year or investing in the stock market depends on your personal situation. But sitting on cash will cost you in the long run.
2. Bet Against the Dollar
So what do you do with that cash? Well, the other side of the equation is that when inflation takes root, a nation’s currency typically devalues. That means you would be wise to bet against the dollar. A number of ETFs allow you to do this. PowerShares DB US Dollar Index Bearish ETF (NYSE: UDN) is an inverse play on the New York Board of Trade’s U.S. Dollar Index. If you’re more sophisticated about currencies and macro trends, you can play exchange rates between the dollar and other currencies like the yen or euro.
3. Get Rid of Treasurys
U.S. Treasury bonds are bad news during an inflationary environment. That’s because as yields start to rise — and at nearly zero, they have to, eventually — bond prices naturally fall. That means you don’t want to be stuck holding the bag.
4. Bet Against Treasurys
You can benefit from the flip side of the collapse in Treasury bonds by shorting them. You can do that by purchasing an inverse ETF just like the previous play on the dollar — for instance, the ProShares UltraShort 20+ Year Treasury ETF (NYSE: TBT). A more sophisticated play is to buy puts Treasury funds such as the iShares Barclays 20+ Year Treasury Bond ETF (NYSE: TLT). Either move not only protects your portfolio from a likely collapse in T-Notes but provides a nice potential for profits.
5. Buy Treasury Inflation-Protected Securities (TIPS)
These types of U.S. Treasury bonds (known as TIPS for short) provide the safety of a government bond with the bonus of protection against inflation. You can buy these outright, or via the iShares Barclays TIPS Fund ETF (NYSE: TIP). Unlike conventional Treasurys, these bonds see their value adjust with inflation to ensure you don’t get eaten up as the dollar fades. If you have any doubt whether or not TIPS work or how bullish Wall Street is on this vehicle, consider that in October the U.S. Treasury successfully executed its first-ever TIPS auction in which the bonds actually had negative yields. That’s because the specter of inflation is so likely that investors were willing to enter the investment in the red with the expectation of rising yield over the life of the investment that makes a short-term loss well worth it.
6. Buy Gold
Gold has already significantly run up in price in 2010 with the expectation of inflation — along with a low-risk, bunker mentality among some conservative investors. But if inflation takes hold, this dollar-backed commodity could soar even higher. If this turns out to be the case, don’t tempted by mining companies. Your best bet is to buy gold through a reputable dealer or through a gold ETF like the SPDR Gold Trust ETF (NYSE: GLD).
7. Buy Crude Oil
Like gold, crude oil is priced in U.S. dollars. As a result, when the dollar drops in value, it takes more dollars to buy the same amount of oil. That means oil prices rise in an inflationary environment, as do profits for pure plays in the crude oil sector. Retail investors cannot trade spot crude, but they can invest in an ETF such as the iPath S&P GSCI Crude Oil Total Return ETN (NYSE: OIL), which reflects West Texas Intermediate (WTI) crude oil futures contracts. Then there are more conventional oil plays such as energy blue chip Exxon Mobil (NYSE: XOM) and pipeline partnerships such as Magellan Midstream Partners (NYSE: MMP), which offer plump dividends.
8. Invest Heavily Abroad
A weak U.S. dollar implies higher returns can be found abroad. After all, if investors won’t be buying Treasurys as readily, they will putting their money somewhere. As for where the opportunity lies, that depends on how much risk you’re willing to take. Many foreign stocks trade on domestic exchanges as ADRs and can readily be traded via your brokerage accounts.
If you are not comfortable investing in a specific stock, you can invest in a specific region or currency via an ETF — such as the iShares MSCI Brazil Index ETF (NYSE: EWZ) as a pure play on Brazil, or the CurrencyShares Canadian Dollar Trust (NYSE: FXC) if you believe in Canada. You may want to consider broader global funds in the ETF and mutual fund arena such as the iShares Emerging Markets Index ETF (NYSE: EEM) or a whichever global mutual fund your 401k provider offers.
9. Invest Sparingly in Domestic Tech Stocks
Technology companies seem to be a bedrock investment for any portfolio. Regardless of economic circumstances, the most innovative computers and software are necessary to our way of life and will always be in demand. Consider the massive launches that Apple Inc. (NASDAQ: AAPL) pulled off in the recession with the 1.7 million iPhone 4 sold in the first three days, or 3 million iPads in about two and half months after its debut. And this doesn’t even acknowledge the weight of corporate IT spending as businesses upgrade networks and optimize productivity with the latest gadgets and software.
You should never put all your eggs in one basket by abandoning the U.S. altogether– but realize that sluggish domestic stocks will suffer in amid a weak dollar environment. To root your portfolio in America, diversify with some domestic tech stocks.
10. Invest Sparingly U.S.-Based Multinationals
Another way to invest in domestic stocks but hedge against inflation is to take shelter in multinationals. Think blue chips like Caterpillar Inc. (NYSE: CAT) and United Technologies Corp. (NYSE: UTX), which saw significant lifts to profits in the fourth quarter of 2009 thanks to a weaker dollar. That’s because a weak dollar actually lifts foreign operations of these multinationals and more than offsets challenges in the states. Consider that a year ago, United Technologies’ CFO told Bloomberg that the company adds $10 million in operating income for each penny the euro gains vs. the dollar! Or in the case of Caterpillar, a weaker U.S. dollar means cheaper exports — so foreign businesses can buy expensive machinery at a better price and are more likely to go shopping. Domestic companies like CAT and UTX are actually helped by a weak dollar — so seek them out as a way to balance your major investments abroad.
Jeff Reeves is editor of InvestorPlace.com. As of this writing, he did not own a position in any of the stocks or funds named here. Follow him on Twitter at http://twitter.com/JeffReevesIP.