Inflation is on everyone’s mind after the Consumer Price Index (CPI) hit its highest level in 40 years.
Price inflation means that the dollars in your pocket are buying fewer lattes, computers, hamburgers, massages, square feet of home, or whatever goods and services you typically buy. This forces you to have to earn more money to maintain your standard of living. Sometimes wages rise to compensate, but not always, and typically they lag the increase in inflation. Maybe you’ll get a pay raise, but it won’t be until after inflation has taken a chunk of your income away.
It gets worse.
Inflation forces people to take more risk with their savings and investment just to keep up (cue the loss porn).
Unfortunately, inflation forecasts also show that it’s likely to get worse before it gets better. The inflation of the 1970’s lasted over a decade before subsiding in the early 1980’s, where we see the “recent” highs in the chart above.
So how do you protect yourself from inflation?
Investing During Price Inflation
Most people think, “if I just invest in the stock market, I’ll be able to stay ahead of inflation.” Big companies have a lot of debt that ought to be easier to repay and they can raise prices on their goods and services, so they should be a safe bet, right?
Unfortunately, the data doesn’t back that up.
Looking at a 2021 paper on investing during inflation, we see that the real returns - i.e. inflation adjusted returns - from holding an index fund lost an average of 7% per year during those inflationary periods.
We can see the impact inflation has on stocks by looking at Turkey over the past 12 years.
At first glance, the BIST 100 - Turkey’s benchmark stock index - looks great, increasing 274% from 2010 to the end of 2021. For reference, the S&P 500 increased 291% over that same time period.
For comparison, we can look at inflation as measured by the Turkish CPI.
Judging by the CPI, the Turkish Lira (which denominates Turkish stocks) has increased by 289% over this same period. If we deflate those 12 year market returns, we’re now looking at a 16% loss over the past 12 years.
That’s not a fun place to be in.
If not Stocks then Where?
Other traditional investments do even worse.
You know that 40% of your 60/40 portfolio consisting of bonds your investment advisor pushed you into? Yeah, that gets destroyed at -8% per year thanks to the central bank’s magic money machine.
What does well are commodities and trend following strategies.
Trend following does great during these periods because it’s trading with the economic winds at its back.
The basic premise of trend following is to wait for prices to rise, then jump on and let the momentum carry you for a long period of time. When the prices start to reverse, you close out your position with a tidy profit.
Additionally, trend followers tend to be highly diversified into a variety of assets - including commodities, equities, bonds, crypto, and other assets - so they jump in wherever the trends exist.
The great thing about trend following is that it is a relatively straightforward strategy to systematize (we have tutorials on how to build your own trend following strategy in Python here and here if you’re interested). It also works in non-inflationary environments as well, making it a great all-purpose strategy to allocate to.
Algorithmic Trading to Tame Inflation
Inflation is here, and it looks like it’s going to stay for some time.
You can continue to trust the government and central banks, Wall Street, and everyone else who put us in this position, or you can take your future into your own hands.
We believe that traders shouldn’t be kept out of profitable strategies by the Wall Street gatekeepers, so we set out to build a platform that will give you access to custom algorithms you can build, test, and trade yourself without knowing how to code or having to pay for expensive data feeds.
Want to give trend following a go? Then build your strategy and test it with just a few clicks.
Think there’s a better algorithmic strategy out there? Then try that instead.
Whatever it is, we want to put the tools in your hands to protect yourself in uncertain economic times.
Check out our free demo to learn more.