News is abuzz with the latest inflation figures clocking in at 7.5%. The US 10-year government bond yield crossed into 2% territory in response to the data. The barrage of news questioning whether the root causes are transitory or secular.
What is especially interesting about interest rates and inflation moving around is lots of assets in the market had reset to pricing reflective of very low yields. In practice it means that people would pay more for cash flows that may materialize far into the future than they would if interest rates are high, and returns today matter more than they did in the past. The net result is a lot more volatility as the market tries to guess what the Federal Reserves actions will be over the course of this and next year to combat inflation.
What is one to do to navigate this environment? The most simple blanket action one can consider is not own assets with very long dated cash flows that make up the vast majority of the cash flows. In plain English, own assets with reasonable cash yields on today’s earnings. Say a 7.5% earnings yield or more. Second, own things that may benefit from a higher rate environment. It’s no surprise that financials and energy have posted positive returns this year while technology has posted losses. Third is to fight the urge to “do something drastic” in light of a lack of simple decisions / investments to make. Keep a shortlist of companies / investments that straightforward purchase decisions, keep a reasonable amount of dry powder available, and continue cautiously investing excess cash flows regularly.