How to invest in a period of surging inflation - opinion

Generally speaking, dividend investing strategies are quite popular and have been profitable in the past.

Calculating taxes (photo credit: INGIMAGE)
Calculating taxes
(photo credit: INGIMAGE)

“It is a way to take people’s wealth from them without having to openly raise taxes. Inflation is the most universal tax of all.” – Thomas Sowell

For the first time in many years, inflation has reared its ugly head. This time it appears to be a global problem. Partly caused by coronavirus lockdowns, and bad government policy we have started to see actual shortages of goods for the first time in decades, and shortages mean that people will pay more to get their hands on the product thus causing higher prices and inflation.

Israel is no different as gas prices and building materials are prime examples of local inflation. Then of course is the price of food. Go to your local supermarket and you will notice that your bill is higher than it was six months ago. I am not even referring to this week’s “investigation” by Channel 12 about the different online shopping options from Shufersal, which gave shoppers cheaper prices on certain goods, through certain websites. The investigative reporter in a moment of self-congratulation, literally just tweeted as I am writing this column that “Due to the investigation on Tochnit Chisachon [Saving Plan]: Shufersal will stop their Mehadrin site on November 15.” Congrats! Now everyone will pay more. This would be a new category of inflation: Let’s call it “stupid reporting” inflation.

The surge in inflation has left many to speculate not if but when interest rates will start to rise. The question is not only when they will start to rise, but how investors should position their portfolios for the much-anticipated new reality.

Conventional wisdom says that as interest rates rise, interest or dividend paying investments will drop. Why? Let’s use an example that is purely hypothetical. Let’s say you own a JP Morgan bond that yields 1.5% per year. If rates are at zero, 1.5% is a good deal and there is demand for that bond. If rates rise and I can get 2% on a government insured deposit, why would I bother with the JP Morgan bond? What then happens is that the price of the bond falls as there is a lack of demand.

Illustrative photo of Israeli money (credit: MARC ISRAEL SELLEM)Illustrative photo of Israeli money (credit: MARC ISRAEL SELLEM)

Based on that basic principle it would stand to reason that stocks that pay dividends would suffer the same fate. After all if you get a 2.75% dividend from Intel stock, that’s great compared with a zero interest rate on a deposit.

But if rates move higher, that 2.75% is much less intriguing and the price of the stock could drop.

Interestingly the theory regarding dividend stocks is not at all crystal clear. In fact if you take a look at some historical figures you will see that high-yielding dividend paying stocks may be the way to go.

According to research from Global X, since 1960 there have been 10 cycles of meaningful interest rate raises. In three of those cycles, dividend stocks underperformed the broader market. In seven of the periods there was significant over-performance from these stocks.

For me those numbers are not too persuasive. I wouldn’t generally advise clients based on that kind of data because it isn’t overwhelmingly pointing to potential success. But if you dig a bit deeper into the data an interesting trend stands out.

According to Global X, “The three instances of underperformance occurred in periods with among the most rapidly increasing interest rates.” This means that in the three periods when dividend stocks underperformed the market, the US Federal Reserve raised interest rates aggressively in a short amount of time. In the seven cycles where high-yielding dividend stocks outperformed, the Fed raised rates over a prolonged amount of time in a much less aggressive fashion.

I think that now many pundits would say that there won’t be many rate hikes and they will be prolonged. I am not sure that this pundit agrees but that’s for another column. If that is true and we learn from history, high-yielding dividend stocks may very well be the way to invest.

Generally speaking, dividend investing strategies are quite popular and have been profitable in the past. Solid companies with long histories of paying dividends (like Johnson & Johnson), tend to be companies doing well and generating profits and substantial cash flow, and they are returning that money to shareholders.

It’s a pretty good sign if a company is distributing dividends to shareholders and still has enough cash left over to expand and grow its business.

There is certainly value in dividend-paying stock investing if done in a context that helps you meet your goals. It also may be the prudent way to invest when interest rates finally rise. Review your portfolio and see if there may be room to incorporate high-yielding dividend-paying stocks in your portfolio.

The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.

Aaron Katsman is the author of Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing.; [email protected]