Investments That Fight Inflation Fears

If rising prices have you worried, here are some pros' ideas about how you can protect your portfolio in the dicey times ahead

By Sonja Ryst

If you're feeling wary about inflation right now, take heed. After hurricanes Katrina and Rita blew energy prices beyond sky-high, the U.S. Labor Dept. said on Oct. 18 that wholesale prices climbed 1.9% in September, their largest month-to-month increase in 15 years. The rise in the producer price index followed a 0.6% increase in August.

So how much will inflation dog the economy during the coming months? Peter Cardillo, chief strategist at Port Washington (N.Y.) investment brokerage SW Bach, says the inflation that has been creeping into the system for the past six to eight months remains a problem -- but only in the short term. He's forecasting that annualized inflation will decline from around 3.5% this year to 2.75% by the end of 2006. "It's quite obvious that the Fed is on top of it," Cardillo says.

The Federal Reserve has hiked lending rates 11 times since 2004, in an effort to discourage people from the borrowing that can contribute to inflation. Meanwhile, prices have already risen for months along with the cost of energy, which took the spotlight after the recent storms hit. Excluding food and energy-related costs, prices rose only 0.3% in September, following no change in August, according to the Labor Dept. (see BW Online, 10/20/05, "How to Ease Inflation's Squeeze").

In an environment such as this, what do the experts say you should do with your investment portfolio? Nothing is certain, says Barry Ritholtz, chief market strategist at investment firm Maxim Group in New York. "I'm a big believer that forecasts are silly, and nobody knows what's going to happen, and that everything is a gross oversimplification."

Still, Ritholtz and other suggest a few options if you fear that inflation will eat away at your nest egg.

Run and Hide: Ritholtz moved about half of his personal retirement money into cash accounts right after Hurricane Katrina. If you own shares that have performed well for the past 6 to 24 months and you're concerned about what happens in 2006, Ritholtz says you might consider halving your exposure to those companies by December. Then you can wait for an opportunity to buy them back for less at some later date.

Go Overseas: Ritholtz says he likes investments in foreign countries whose governments have strong credit ratings (which makes them defensive bets) and whose economies include growing natural resources or industrial manufacturing industries. As examples, he cited the iShares MSCI South Korea Index Fund (EWY ) and the iShares MSCI Taiwan Index (EWT ), which track those countries' local markets. (For more on foreign investments, see BW, 10/24/05, "Europe's Hot Growth Companies" and "The Best Asian Performers").

Take Some TIPS: Barclays Capital is among those who sell Treasury inflation-protected securities, or TIPS. The firm's inflation strategist, Michael Pond, says if an investor is expecting higher inflation, then it's implied that the TIPS should appear attractive. "It's as simple as that," Pond says.

A 10-year Treasury bond currently trades for a yield of about 4.45%, while the comparable TIP pays a significantly lower yield of 1.90%. However, the principal on the TIPS bond is adjusted for inflation, based on the consumer price index. You can get lots of information about TIPS from the Treasury Dept.'s Web site.

Chase the Gold: As of late September, Joe Battipaglia, chief investment officer at full-service brokerage Ryan Beck & Co. in Florham Park, N.J., has been recommending that investors allocate from 5% to 15% of their portfolios to gold, up from 3% to 9% earlier. "Demand for gold is rising in India and China as a function of their economic development," Battipaglia says.

But December gold futures prices are trading at around $470.80, near 17-year highs. How much higher can this stuff go? Battipaglia points out that the record high for gold was about $800 an ounce back in the late 1970s and early 1980s, when mortgage rates were in double digits. Plus, he says, the pundits are battling about whether inflation will strain the U.S. economy and bond markets (see BW Online, 9/21/05, "Gold's Deceptive Glitter"). "Typically, when those things occur, gold gains more luster," he adds. Indeed, it already has some.

Ryst is a reporter for BusinessWeek Online in New York

Edited by Phil Mintz

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