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Right now, inflation has some investors worried. While many were poring over the latest COVID-19 data to guide their investment activities some months ago, traders and investors in both the UK and US have now turned their attention to their respective Consumer Price Index (CPI).

 In the UK, it is a similar story, as data at the beginning of August revealed that inflation overshot the Bank of England’s (BoE) forecasts for three successive months, although figures have now shrunk back down to the target rate of inflation. However, on leaving his role as the chief economist at the BoE, Andy Haldane had some blistering critique to offer about the central bank’s actions to head off the threat of inflation, suggesting that figures will reach 4%, which is double the BoE’s target, by Christmas.

Clearly, his comments provide traders and investors with some food for thought. Although central banks have for now been asserting that inflation woes are just temporary, investors must hedge their bets. Should we be headed for a protracted period of high inflation, many will no doubt find themselves in a position where they could see their portfolio’s profit eroded and their returns diminished, as an increase to their cost of living.

So, how can these risks be mitigated?

Monitoring inflationary risks

Throughout the COVID-19 pandemic, investors will be all too familiar when it comes to monitoring the release of new data and figures shedding light on how the situation is developing. Where inflation is concerned, I would advise traders and investors to eye a different set of figures.

Those in the UK should monitor the aforementioned CPI or the Harmonised Index of Consumer Prices (HCIP), which tracks the change in price of goods and services over time. Measures of inflation and prices here include consumer price inflation, producer price inflation, and the House Price Index, which should give investors some perspective.

Meanwhile, in the United States, investors can also look to CPI data. That said, while this is the most widely followed indicator, it is important to note the fact that the Federal Reserve tends to emphasize the Expenditures Price Index (PCE), which covers a wide range of expenditures.

In addition to these measures, it would also be wise to monitor how far off central banks are from meeting their target rate of inflation, as well as any diverging views from members of the Monetary Policy Committee (MPC) or the Federal Open Market Committee (FOMC).

Is gold a good hedge against inflation?

Beyond central banks watching and monitoring the latest consumer data, investors will likely require some careful rethinking where their investment strategies are concerned.

Typically, gold is seen as a good hedge against inflation because it lacks credit or default risks. When interest rates are down, gold prices go up, and this is directly proportional to the strength of the economy. Simply put, gold is a hedge against a falling economy.

Given that we are living through a highly unusual set of circumstances, it is important to note that comparisons to historical data weighing up the strength of gold as an inflation hedge might not be applicable. That said, while gold can be highly volatile in the short-term, it will generally hold its value in the long-term, so this is something investors should bear in mind.

Growth stocks vs. value stocks

In general, inflation is usually negative for stocks, and the history books stand up to bolster this fact. Indeed, if money in the future is worth less as a result of rising prices, then certainly this can cause the value of investments like growth stocks to falter. This is because these assets have cash flows that go far out into the future, and as such, inflation can place these earnings expectations in danger, damaging the future profitability of any companies in question. 

But this is not always the case the case for stocks. Value stocks, for example, have a higher intrinsic value than their current trading price, and generally tend to outperform growth and income stocks. By looking to established companies and strong current free cash flows (in essence, the kinds of stocks that always perform well), investors might find more security. Although cash flows may lessen over time, this will largely depend on whether investors take a long- or short-term view of the market.

At the moment, it is uncertain how the inflation story will play out. In many ways, mild inflation (around 2% or 3%) can actually be good news for investors, offering the highest real returns, as well as signaling a strengthening economy. But only time will tell, and investors would be wise to factor in these considerations when mapping out their investments.