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The annual inflation rate in the U.S. accelerated to a more than 40-year high of 9.1% in June 2022, experiencing the fastest increase in prices since November 1981. While the inflation rate slowed to 8.3% in August, we will likely see continued upward pressure on most prices for some time to come.
Yet, despite the current environment of dropping stock prices and skyrocketing inflation numbers, some assets are well-positioned to benefit. Farmland, for example, tends to perform well in inflationary environments, enjoying jumps in both land valuations and commodity prices. Historically, farmland returns have had a roughly 70% correlation with the CPI. Let’s explore the factors driving prices upwards and how these trends have historically impacted some of the top asset classes.
Factors driving inflation
As a result of heavily stimulating the economy during the Covid-19 pandemic, the M2 money supply increased by over 40% from March 2020 to June 2022, while the M1 money supply grew 5x. This influx of money into the economy helped drive prices to a 40-year high; commodities like food now cost 10.4% more than one year ago.
Shipment delays resulting from lockdowns, worker shortages and slow port turnaround times are causing ongoing supply constraints worldwide. In turn, consumers are facing higher prices due to pass-through costs and input scarcity. Though they have begun to decline, fertilizer prices, for example, increased 80% in 2021; earlier this year, prices jumped an additional 30%.
The Russia/Ukraine war is compounding inflationary pressure, particularly on global food prices. Russia and Ukraine are major suppliers of commodities, particularly staples like wheat and corn; combined, the two countries export roughly 25% of the world’s grain. Due to sanctions against Russia and transportation challenges within Ukraine, only a fraction of this supply has been accessible to the rest of the world. As a result, wheat prices jumped 37% during the first two months of 2022, while corn prices rose by 21%.
While every period of inflation is different, the historical performance of some of the top asset classes can indicate how each may act in today’s environment. Let’s take a look at how inflation might impact some of these top asset classes below:
In general, real returns of stock prices tend to decline when inflation rises. In fact, from 1979 to 2021, public equity returns have been substantially lower when inflation is over 4.1%. This performance is driven by higher prices for inputs, causing many companies to experience lower profit margins. In addition, stricter monetary policy discourages borrowing due to higher costs.
However, some stock market sectors tend to benefit in times of inflation. Soaring oil and other commodity prices, for example, have led energy sector stocks to generate record profits in 2022; the Energy Select Sector SPDR Fund (XLE) is up 42% this year.
Stricter monetary policy in response to inflation has historically negatively impacted fixed-income securities. When the Fed increases interest rates, as we’re seeing today, bond prices tend to drop as yields become more attractive. As a result, the correlation between stocks and bonds becomes strongest during long periods of high inflation, meaning bonds can also lose their diversification characteristics. This can amplify volatility, particularly for investors that rely on a “60/40” portfolio.
Historically, inflation and housing prices tend to move in the same direction, making real estate a popular hedge against inflation. Inflation also can benefit investors who earn income from rental properties, as higher home prices often equate to higher rent. However, higher interest rates often cause investors to demand higher cap rates, which can negatively impact commercial real estate valuations. In addition, commercial real estate may be locked into long-term agreements that can’t be adjusted for inflation or rate changes.
While the track record for digital currency isn’t long, it was recently found that cryptocurrency does not seem to be as strong of an inflation hedge as was originally predicted. From mid-April to mid-July, cryptocurrency was found to have a 95% negative correlation to 10-year U.S. inflation-indexed bonds. Not only does cryptocurrency move opposite of inflation, but it has also recently failed to preserve asset value, with Bitcoin’s recent peak drawdown reaching a loss of almost 72%.
The long-term appreciation of farmland is driven by two major trends: growing food demand and land scarcity. Quality farmland is becoming increasingly scarce worldwide; the United States lost 1.3 million acres in 2021 alone. At the same time, the global population is expected to hit eight billion people later this year while topping more than nine billion by 2050. To meet the expected global demand, farmers will need to double the amount of food over the next 50 years — all while using less land.
In addition to price appreciation, farmland investors can also benefit from the annual cash yield generated by farming operations. Therefore, when commodity prices increase, farmland returns should increase, too. As a result, farmland has been historically well-situated to protect asset value and generate income, particularly during times of inflation. In a 50-year study of farmland returns (1970 to 2019), annual farmland returns were more than 2.5 times higher than the average yearly CPI rate.
Despite falling prices in August 2022, many predict inflation will hover around 8% through the rest of the year. While inflationary fears continue to run high, both domestically and overseas, an opportunity also abounds for investors — through both traditional and alternative options.