Inflation Also Rises

Nothing seems to trouble Cathie Wood, the celebrity founder and manager of ARK Investment Management.

one dollar bill is sprayed in the hand of a man on a black background

Source: SERSOLL /

Last April, in response to a question from Tesla (NASDAQ:TSLA) co-founder Elon Musk, she dismissed the stock market’s record-high valuations as irrelevant.

Then, earlier this week, when Twitter (NYSE:TWTR) founder Jack Dorsey mentioned the threat of “hyperinflation,” Wood tweeted an immediate rebuttal: “Three sources of deflation will overcome the supply chain-induced inflation,” she insisted. “Technologically enabled innovation is deflationary and the most potent source.”

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In other words, Don’t worry, be happy.

Woods may well be correct. Certainly, her glittering resume lends credence to her rose-colored outlook. But I would take the other side of that trade.

Yes, technological innovation is a marvel of incalculable scale and power. But even technology has its limits.

Technology by itself cannot prevent the Treasury from printing one inflationary dollar too many. Nor can technology overcome physical, supply-chain bottlenecks to transport a cargo ship full of semiconductors from Taiwan to an electric vehicle (EV) factory in Kentucky.

A Vicious, Cyclical Trap

Current monetary trends, coupled with supply-chain constraints, wield a powerful inflationary force that technology might not be able to offset… at least not immediately.

Furthermore, financial markets are cyclical, no matter how much we might like them to be otherwise. Stock valuations cycle from very high valuations (like they are today) to lower valuations… and then return higher once again.

Interest rates do the same thing.

Once upon a time, interest rates were very, very high. Today, they are very, very low. A return to something in between the two seems like a reasonable bet, especially because so many inflation gauges are flashing red.

As we older folks well remember — and younger folks may have read in a musty textbook — soaring inflation rates often produce soaring interest rates.

During the inflationary episode of the Vietnam War years, for example, the 10-year treasury yield doubled from 4% to 8%. Although that rate must have seemed quite high at the time, it would double again during the hyper-inflationary 1970s when it skyrocketed to nearly 16%.

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But it’s been all downhill ever since. The generally tepid inflation readings of the past four decades have fostered a gradual drop in interest rates to near-zero. This delightful decades-long episode has emboldened an entire generation of investors to subsequently develop a near-zero fear of inflation.

To put it another way, four decades of low inflation readings have persuaded bond investors that a 1.52% yield on a 10-year treasury is a reasonable return.

In fact, bond investors seem quite content with that 1.52% yield, even though CPI inflation readings are hitting 30-year highs.

A chart showing CPI inflation readings between 1961 and the present.

The Necessary Ammo

Now, inflation can be especially fatal for fixed-income investments like long-term bonds. As I pointed out in a previous edition of Smart Money, the price of today’s 30-year Treasury bond could suffer a severe haircut if inflation continues inching higher.

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For example, if rising inflation caused 30-year interest rates to rise from 2.0% to 3.0% over the next 12 months, the value of that bond would fall 20%.

If 30-year rates doubled from 2.0% to 4.0%, the price of the 30-year bond would tumble more than 35%.

Inflation can also pull the rug out from under the stock market. Because of these risks, investors from earlier eras would buy precious metals to hedge against inflation.

In the modern era, gold may or may not provide its usual protection. The inflation-fearing Dorsey, for example, is not turning to gold for protection. Instead, he advocates an allocation to Bitcoin.

But rather than buying either gold or cryptos, some investors might prefer a more direct hedge against inflation… like selling short long-term bonds.

Selling short means betting against a stock or some other financial asset. Unlike typical trades that benefit from a rising price, a short sale benefits from a falling price.

Therefore, an investor who sold short the 30-year Treasury bond at today’s prices would make money if a rising inflation rate caused bond prices to fall.

For most investors, the process of short selling seems difficult and confusing. Conveniently, however, several “short-focused” ETFs do the heavy lifting themselves and provide an easy way for ordinary folks to “sell short” different sectors of the bond market.

One of these ETFs is the ProShares Short 20+ Year Treasury ETF (NYSEARCA:TBF). It bets against long-dated treasury bonds. The guts of its portfolio are interest-rate swaps that increase in price as long-term interest rates rise. As such, this ETF offers a direct and “clean” hedge against inflation.

This ETF has been a big loser for most of its 12-year existence. But that’s because interest rates trended lower during that period.

If interest rates were to begin heading significantly higher, instead of lower, this ETF would finally reward its shareholders.

Inflation is a critical topic as we approach the new year — I dedicated a story to it in the most recent Fry’s Investment Report monthly issue.

There, we explore more hedging options (especially if you’re a more daring investor), as well as which trends will carry us into 2022 — and beyond.

Go here now to get the details.


Eric Fry

P.S. I predicted the tech wreck in 2000, the real estate crash of 2008 AND the stock market collapse of 2020. Now I’m issuing a new alert. Click here.

On the date of publication, Eric Fry did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Eric Fry is an award-winning stock picker with numerous “10-bagger” calls — in good markets AND bad. How? By finding potent global megatrends… before they take off. In fact, Eric has recommended 41 different 1,000%+ stock market winners in his career. Plus, he beat 650 of the world’s most famous investors (including Bill Ackman and David Einhorn) in a contest. And today he’s revealing his next potential 1,000% winner for free, right here.

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