Stansberry Research

Thriving in Inflation's Next Stage

Dr. David EifrigStansberry Digest

Editor's note: It's time to prepare for the next phase of inflation...  

You see, inflation figures for October came in better than expected. And this could tempt some investors who have been hiding their money on the sidelines to reenter the market...

But Income Intelligence editor Dr. David "Doc" Eifrig believes this rare positive news won't prevent inflationary pressure from weighing on stocks in the long term. That's why he says it's crucial for investors to remain patient and not rush back into the markets...  

In today's Masters Series, originally from the February issue of Income Intelligence, Doc compares today's sky-high inflation with the rampant inflation seen during the 1970s... details how this high inflationary pressure is weighing heavily on stocks... and reveals how this ongoing chaos could create a slew of buying opportunities in the months and years to come...  


Thriving in Inflation's Next Stage

Dr. David Eifrig, editor, Income Intelligence

It's like calling Michael Jordan "a retired Chicago athlete" or referring to Paul McCartney as "a songwriter from Liverpool."

But when Warren Buffett took to the pages of Fortune in 1977, the magazine felt obliged to introduce him to its readers...

Buffett, who is now forty-six years old and still operating out of Omaha, has a diverse portfolio. He and businesses he controls have interests in over thirty public corporations. His major holdings: Berkshire Hathaway (he owns about $35 million worth) and Blue Chip Stamps (about $10 million).

Even then, Buffett was a fairly prominent investor. Today, he's a household name... well-known far outside financial circles. And that $45 million ownership of Berkshire and Blue Chip has grown into $114 billion worth of Berkshire Hathaway. (Blue Chip Stamps merged into Berkshire Hathaway in 1983.)

Through all the changes, though, Buffett's Fortune essay contains lines that could be written today – simple yet valuable wisdom and an insightful summation of challenges we face.

First, Buffett diagnoses the causes of the most recent 20-year bull market – and the story looks eerily similar to today...

Stock investors can think of themselves in the 1946-66 period as having been ladled a truly bountiful triple dip. First, they were the beneficiaries of an underlying corporate return on equity that was far above prevailing interest rates. Second, a significant portion of that return was reinvested for them at rates that were otherwise unattainable. And third, they were afforded an escalating appraisal of underlying equity capital as the first two benefits became widely recognized.

In other words, businesses earned high profits and reinvested them at good growth rates, and the valuations on all stocks rose. But before long...

This heaven-on-earth situation finally was "discovered" in the mid-1960's by many investing institutions. But just as these financial elephants began trampling on one another in their rush to equities, we entered an era of accelerating inflation and higher interest rates. Quite logically, the marking-up process began to reverse itself. Rising interest rates ruthlessly reduced the value of all existing fixed-coupon investments. And as long-term corporate bond rates began moving up (eventually reaching the 10 percent area), both the equity return of 12 percent [Buffett's estimate of the long-term average] and the reinvestment "'privilege" began to look different.

Buffett looks at inflation as the driving factor for the future, but...

Which brings us to the crucial question – the inflation rate. No one knows the answer on this one – including the politicians, economics, and Establishment pundits, who felt, a few years back, that with slight nudges here and there unemployment and inflation rates would respond like trained seals.

And, as always, society doesn't change much...

Most of those in political office, quite understandably, are firmly against inflation and firmly in favor of policies producing it.

The essay, titled "How Inflation Swindles the Equity Investor," dealt with the inflation rampant in the 1970s – again, a similarity to today – and Buffett's conclusion was that stock returns going forward would be lackluster. Sure enough, the S&P 500 Index returned just 5% a year for the next three years – failing to keep up with 9% inflation – before inflation started to decline.

In the essay, Buffett relays what makes inflation so tough on stocks. The fact that inflation can make stocks struggle looked obvious at the time – though the reason why was anything but.

Today, however, we seem to have forgotten this lesson. And we'd do well to take heed... and specifically buy the type of stocks that Buffett's prescription tells us will do well during inflationary periods.

Every inflation report makes headlines, especially when it keeps hitting new highs.

The most recent report for October inflation came in better than expected at 7.7%...

We've written at length about inflation, how it works, and how it was coming... and we did it well before it came.

Now that it's here, it's time to shift gears.

We're entering a new stage...

The first stage was the shock of inflation. That's when people don't expect inflation – and it comes and slaps them in the face.

This quickly changes people's behavior, dislocates asset prices, and leads our politicians to dramatically shift their rhetoric (though not, of course, their policies).

That has already happened. It's not quite over, and it's not our place to pinpoint the exact date it will end, but now we're looking to the future.

Because after the shock comes the grind...

That's where there's still intense inflationary pressure in the economy, but less than the recent 7.7% level. It doesn't mean 1% or 2% inflation, at least not for a while. We're building our outlook around inflation of about 4% or 5% for a couple years.

That's the grind... Prices keep edging higher – across the economy. And that makes a big difference to your daily life because prices compound. If prices rise 5% a year for five years, your weekly grocery bill ends up 30% higher. (Of course, you've likely seen a bigger jump than that already.)

So now, we're looking at the longer term. We're not trying to anticipate the market's reaction to the news of inflation – we're focusing on how persistent inflation will drive the prices of different assets and how to position ourselves as investors.

You might think that sounds simple enough. It's not...

Buffett starts his 1977 essay, "It's no longer a secret that stocks, like bonds, do poorly in an inflationary environment."

At that time, inflation ripped through the economy and hammered the stock market...

Like now, many 1970s investors had also expected stocks would do better than bonds because businesses can raise prices. However, stocks did the opposite. And that caught a lot of people wrong-footed.

Every inflationary period is different. Bull and bear markets happen for different reasons. And if you look at the relationship between stocks and inflation, it's hard to discern a clear relationship...

Perhaps the 1970s were a unique time with inflation, economic stagnation, and therefore falling stocks. And that unique time is skewing our ability to study stocks and inflation.

We just don't have enough data yet...

It's a simple theory that businesses can raise prices to counteract inflation, keeping their stock values safe. We've shared that theory with you before, and it may well prove correct. But for whatever reason, it didn't happen in the '70s.

But that doesn't mean we can't find stocks that will thrive...

Good investing,

Dr. David Eifrig


Editor's note: Doc has a proven record of finding the best investing opportunities – no matter what's happening in the markets. In fact, he accumulated a string of 144 straight wins... even in this down market. And now, he's coming forward to share the single most important idea of his life...

Doc says this one idea could transform your life in ways that go way beyond money. And folks who act now will be in a much better position than anyone else almost immediately. Click here to get the full details...