PROFITABLE ASSETS DURING INFLATION

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Sola Oni writes that investment in real estate works well with inflation

On Tuesday, December 29, 2020, The Nigerian Stock Exchange hit headlines as the world’s best-performing stock market by Bloomberg’s ranking. The bourse’s Year-to-Date returns amounted to +45.70 percent while the market capitalization was N20.447 trillion. Investors on The Exchange have been enjoying sustained increase in transaction with spike in equity prices since last month and it may continue till early this month. In the stock market parlance, this is called Santa Claus Rally or Calendar Effect. The rally, whose annual consistency is arguable, is believed to occur in the last week of every December through the first few trading days in January. Proponents of the rally ascribe it to tendency by investors who are income-tax sensitive to claim capital loss and reinvest it at the beginning of the year. Another reason is that some investors utilize payment of year-end bonuses in January to purchase stocks and both activities drive up prices.

Equity investment has become the nerve center of transactions on The Exchange in recent time as one of the most profitable asset classes when return on fixed income securities and money market instruments have crashed due to the monetary policy of the Central Bank of Nigeria (CBN) among other factors. But the elephant in the house for equity investors is the double-digit inflation which hit a three-year high of 4.9 percent in November with fears that it will rise further. Inflation measures the average price level of basket of goods and services in an economy. Some of the propellers of Nigeria’s double-digit inflation are insecurity in farming areas with attendant effects on food supply and shortages of dollar. It is settled in corporate finance that return on capital does not rise with inflation. Also, return on equity (ROE) depends on whatever returns the company earns and it is not fixed. This may put equity investors in a helpless position.

However, an investor that has a long-term view can use stocks to hedge against inflation. Stocks tend to grow in value in the long term while holding a diversified portfolio such as 60/40(Stock/Bond) has potential to protect an investor from declining purchasing power. Value stocks, inflation-protected bonds, and real estate are silver bullets that attack inflation. A value stock refers to companies whose shares trade below intrinsic value otherwise called undervalued stocks. The security is identified by features such as high dividend yield and low price-to- book ratio (P/B ratio). The companies are noted for superior return. They are large and well-established. This is different from growth stocks which are shares of the companies that are expected to outperform the market over time because of their future potential. But growth stocks may refrain from paying dividends as it will reinvest retained earnings for expansion. An investor’s choice of growth or value stock depends on his investment objective, time horizon and risk tolerance.

Bonds can be linked to Consumer Price Index (CPI) whereby the principal is reset according to changes in index. This is where investors should contact their investment advisers. Under the current challenges in the global financial market, inflation-linked bonds and Exchange Traded Funds (ETFs), a basket of securities tradable on The Exchange can play vital part in protecting portfolio’s value. Investment in real estate works well with inflation. As inflation rises, property values rise accordingly, and landlords charge higher rental income. In the United States, there are Treasury Inflation-Protected Securities (TIPS) issued by the government. They are indexed into inflation to protect investors from a decline in the purchasing power of their money. Other assets that hedge investors against the scourge of inflation are: Real Estate investment Trusts (REITs), commodities such as gold, oil, metal, and grain.

The stock market investment legend, Warren Buffett has always remained vocal on how to invest during inflationary period. Buffett’s company, Berkshire Hathaway, had in the late 1970s and early 1980s devoted significant portions of its annual letter to investing in stocks during inflationary periods in the United States of America. Buffett had reportedly warned before the global financial crisis in 2007 and 2008 that “inflation would cause a shock, and after the crisis, central banking policy would ultimately force a reckoning in stocks.” As an ardent believer in stocks, his timeless statement is “Be fearful when others are greedy and greedy when others are fearful”. From his practical experience, he believes that inflation swindles equity investors and therefore offered some tips for equity investors: When you are doing great, it is time to remember inflation: During high inflation, earnings are not the dominant variable for investors: Understand the math of Misery Index; Inflation is a tapeworm that makes bad businesses even worse for shareholders: Focus on companies that generate rather than consume cash: Corporations cannot out-manage government and there is no solution to inflation, but there’s reason for hope. Happy New Year.

Oni, award winning Financial Journalist and Chartered Stockbroker is the Chief Executive Officer, Sofunix Investment and Communications