The Threat of Inflation

Lost in the debate over the recession, the bear market and the potential ways in which to recover from both has been the general upward movement in commodity prices and the associated inflationary effects of these movements.  In fact, one Wall Street analyst has suggested that lower demand for commodities should keep inflation in check for the balance of 2009.  I do not subscribe to this point of view and contend that inflation could have a crippling impact on a stock market that we believe will start to form the foundation of a sustainable recovery during the second half of 2009, and on a U.S. economy that will likely not start to show signs of growth until the end of the year.

The “re-emergence” of emerging markets that we are predicting for 2009, for which we have already seen evidence of during the 1st quarter of 2009, will involve heightened demand for natural resources to keep pace with the growth of these emerging countries (examples include China and Brazil).  As our supply of natural resources on this planet is limited, this heightened demand should naturally lead to an increase in commodity prices.

Increases in commodity prices; specifically crude oil, gasoline and wheat, could cause U.S. consumers to reign in their already curtailed spending to meet these higher prices.  This lack of spending could impede economic growth and strangle recession recovery efforts.  Remember that consumer spending currently accounts for our 70% of economic growth as defined by Gross Domestic Product (“GDP”). While the magnitude of inflationary pressures is not known at this time, I am confident that the threat of future inflation is very real despite recent statements by the Federal Reserve that they remain ready to deal with inflation, by draining liquidity (according to Jon Hilsenrath’s Wall Street Journal article entitled “For Fed, Big Test Will Be When to Turn Off the Money Pump,” the Federal Reserve has pumped more than $800 billion of cash into the nation’s financial system in the past eight months) and raising interest rates, when the focus turns from economic stimulation to inflation dampening.  

As a result, we, at Hennion & Walsh, feel that including an appropriate amount of inflation hedge-oriented investments, such as gold, baskets of commodities, diversified equities and Treasury Inflation Protected Securities (“TIPS”), are worthy of consideration for most investment portfolios.