Apparently, inflation is the biggest risk to the stock market right now. That’s according to the latest data from Bank of America.
Source: Hedge Fund Tips
That might bring about a downturn in share prices. But investors who are prepared probably don’t need to worry too much.
Where to find inflation protection?
Inflation has reached 3.8% in the US (though the UK situation is much more positive). And investors have a few ways of responding.
Source: Trading Economics
One strategy is to try hedging. This involves buying something that’s likely to go up in price if inflation keeps going strong.
The classic example is actually outside the stock market. Inflation tends to lead to lower bond prices as the real value of fixed returns falls.
As a result, one strategy is to go short something like the 20-year US government bond. And there are a few ways to do this.
One is via options on the iShares 20+ Year Treasury Bond ETF. That’s something a professional fund manager might look at.
The downside to this is that it’s complicated. And for ordinary investors, I think there are much more straightforward alternatives.
Strategies for ordinary investors
Institutional investing is different to retail investing. And ordinary investors have a huge advantage in a stock market crash.
With professional fund managers, their clients start looking elsewhere if they have a bad three months. This doesn’t happen to ordinary investors.
The result is that most people don’t need to hedge their portfolios the way professionals do. If stocks go down, they can just sit and wait.
According to Warren Buffett, the stock market transfers wealth from the impatient to the patient. And this gives retail investors a big advantage.
The trouble is, they risk throwing this away by doing things professionals do. In doing so, they turn opportunities into challenges.
It’s unwise, though, to ignore the threat of a stock market crash entirely. So what should ordinary investors do instead?
Which businesses are helped by inflation?
Investors need to think about what inflation means for their investments. But that means the underlying businesses, not just share prices.
Some businesses are more resistant to inflation than others. Cross-border payment platform Wise (LSE:WISE) is one example.
Higher prices mean higher transaction volumes. And since Wise makes money by taking a fixed percentage of these, its revenues naturally increase.
That works to a point. If inflation gets out of control and spending dries up entirely, the effect could be lower payment volumes.
The firm also has another defence against inflation – its scale. More users and more payments bring down the cost of any single transaction.
