inflation Archives - Page 3 of 3

Going, Going, Gone! Is Inflation Running Away with our Money and our Investment Returns?

Written February 24, 2022February 24, 2022 by Ailie Carlene Elmore

On the field that is the U.S. economy, currently loading the bases are looming interest rate hikes, the value of the U.S. dollar, and rising Treasury yields. On the mound, is Federal Reserve Chairman, Jerome Powell, and everyone from investors to consumers are waiting to see what will happen next with monetary policy and the economy. Early in the game, the COVID-19 pandemic threw a curveball, and ever since, the economy has been dribbling a series of weak grounders from persistent unemployment, to supply chain disruptions and a declining labor force participation rate. Will Chairman Powell toe the rubber to strike out runaway inflation and imperil economic growth or is the US economy in for extra innings?

How did inflation get so out of hand?

The U.S. Bureau of Labor Statistics reported that in January 2022, the consumer price index rose 7.5% from January 2021, the highest rate of inflation since February of 1982. Some of the industries seeing the largest price hikes are the energy, gasoline, housing, and food sectors which is of no surprise for anyone who has bought groceries or visited the gas pump lately. Even with the rise in prices, it hasn’t generally stopped consumers from spending. The Commerce Department reported that retail sales are up 3.8% year over year with large gains reported in vehicle, furniture, and building supply purchases. Home sales have been on the rise as well with the National Association of Realtors citing that home sales in January were up 6.7% from the previous month. This comes as home buyers are trying to secure financing at lower interest rates before the anticipated Federal Reserve rate increase next month.

Source: SpringTide US. Inflation Trends

While this level of inflation is unlike anything Americans born after the 1970s and early ‘80s have ever experienced, many economists are not surprised by this spike in the CPI. The federal government has shelled out more than $3.5 trillion in COVID-19 relief funding in the form of stimulus checks, unemployment compensation, and the paycheck protection program. The figure below shows the allocation of this spending with more spending earmarked through 2030 as the government continues to combat the aftershocks of the pandemic. The excess liquidity in the market, combined with the supply chain disruptions and labor shortages, has created the perfect cocktail for inflation to brew. While this spending was necessary to keep the economy out of a recession, some argue the federal reserve hasn’t been aggressive enough in unwinding its pandemic era policies to combat rising inflation. The Federal Reserve has announced that rates will start to rise in March, but by how much? Experts, such as economists at Citibank, are predicting anywhere from a 25 to 50-basis point hike with the later end of the spectrum becoming more likely as inflation rises. They are then expecting three to four more 25-basis point hikes by the end of 2022. Economists feel this could help slow inflation by the end of the year, but supply chain disruptions and incipient wage inflation risk still loom.

Source: CNBC analysis of Treasury data compiled by the Pandemic Response Accountability Committee

Is 2022, the new 1980?

The survivors of the last battle with inflation in the 1970s and 80s know all too well what runaway inflation looks like. It has some questioning whether we are in for a blast from the past in 2022. Inflation peaked in 1980 at 14.8% and while we haven’t hit those levels yet, the jump we have experienced has people on their toes for a line drive heading for them. Inflation in the ’80s was driven by a variety of factors from unpredictability in interest rates to soaring oil prices. Most economists believe that this time is different than the 1980s as recent inflation has been caused by COVID-19 aftershocks of excess liquidity and supply chain issues. These factors are expected to normalize over time.

Examining our Investment Strategy

Markets have been off to a shaky start in 2022 with inflation and geopolitical risks in Russia & Ukraine driving the recent volatility. Economists and investors worry that if war broke out between Ukraine and Russia, it could cause more supply chain disruptions of commodities which could prolong inflation. While the Federal Reserve’s announcement of a March interest rate increase has curbed some concerns about more inflation, these new geopolitical risks could overshadow efforts to reduce inflation through monetary policy. As a result, investors are watching markets closely in addition to exploring inflation-protected physical assets such as gold or farmland. Below is the historical correlation between several asset classes and the consumer price index using returns data from 1970-2020. The CPI has historically had a positive relationship with bonds and precious metals but a negative relationship with equities.

Source: Data supplied by the TIAA Center for Farmland Research

Physical assets such as precious metals and farmland have taken center stage the past few months with gold values up 5.3% year to date and farmland values up 22% in parts of the Midwest since this time last year. While these physical assets have been investors’ go-to during high inflationary periods in the past, investors have also been allocating more of their portfolios to cryptocurrencies as well. Cryptocurrencies have a relatively short history compared to traditional assets which makes it difficult to analyze their performance with inflation, however, some investors are calling it “digital gold.” Even Mr. Wonderful, Kevin O’Leary, claims that his portfolio has more holdings in cryptocurrencies now than gold. Crypto enthusiasts cite its ability to be shielded from the effects of government money printing and spending largesse.

Servant Financial has been keeping tabs on inflation and has updated its investing strategy accordingly based on investors’ risk tolerance. While we are still allocating a portion of portfolios to equities and fixed income instruments, we’ve had a higher portfolio tilt towards allocation to precious metals, real assets, and Grayscale Bitcoin Trust (BTC) as protection for client portfolios from inflation. INFL, Horizon Kinetics Inflation Beneficiaries ETF, has recently been added to the portfolio as well. It is an actively managed ETF designed to capitalize on growing inflation trends. Currently, INFL has $896 million assets under management with holdings in transportation, financial exchanges, energy and food infrastructure, real estate, and mining companies. While INFL has a diverse group of global holdings, its top holdings are in PrairieSky Royalty (Oil & Gas), Archer Daniels Midland (Food & Agribusiness Processing), and Viper Energy Partners (Oil & Minerals).

While inflation has threatened investors’ portfolio returns, an adjustment in investment strategy for the purposes of inflation hedging will help investors score in the performance game in the later innings of this economic cycle. A watchful eye must be kept on key economic signals such as changes in interest rates, inflation trends globally, and the supply chain normalization. If you would like to discuss your asset allocation so you can do well in all facets of the investment game like the alert and observant Willie Mays, the Say Hey Kid (Say who. Say what. Say where. Say hey.), contact Servant Financial today.

Through the Looking Glass – Investment Themes to Watch in 2022

Written January 25, 2022 by Ailie Carlene Elmore

The world has been riding the COVID-19 rollercoaster for the past two years. Similar to Alice’s adventures in Through the Looking Glass, the twists and turns of the pandemic have been reflected in our everyday life and the investment world. Financial markets have experienced extreme highs and lows as the market digested economic data and expectations about COVID-19 cases and incoming variants. Even the map of S&P 500 levels mimics a roller coaster you might see at your favorite theme park. Despite the economic and social volatility over the past two years, the S&P 500 returned more than 26% in 2021.

Graph of S&P 500 levels January 2020 – December 2021

So where will Alice go next in the looking glass? Specifically, what should investors be reflecting on as we look towards 2022? With this in mind, we have identified a few opportunities as well as some things to watch in the investing world in the upcoming year. More details will be provided on these topics in the upcoming months however investors should be aware of these opportunities and market risks as we start the year.

Inflation

One of the greatest market concerns early on in 2022 is rising inflation levels. From food in the grocery stores to gas at the station, the price of everything is going up. The U.S. Labor Department recently reported that consumer prices rose 7% in December 2021 from the price level in December 2020. This comes after November 2021 consumer prices rose 6.8%. A Wall Street Journal survey showed that respondents believe inflation levels will come down gradually in 2022 as a Federal Reserve interest rate hike is expected in early 2022 in response to inflation well above its 2% target and a low unemployment rate of 3.9%. Survey respondents also are projecting economic growth to slow in 2022 to a 3.3% increase in GDP which is significantly lower than their October expectations of 4.2%. As a result of these economic drivers, investors are flocking to real assets such as farmland, commodities, and precious metals. Commodities, including energy, and precious metals are the top-performing sectors so far in 2022. Nationally, farmland experienced a 7% increase in values in 2021, and agricultural commodities and farmland are projected to continue rising in 2022. If you are interested in investing in farmland coupled with tax benefits, learn more on Promised Land’s website.

Wall Street Journal Survey Report

The Next Gold Rush

The rise in inflation expectations also has some investors seeking protection in physical assets such as Gold. Gold is another asset that has been known to offer investors inflation hedging potential however the volatility in the COVID-19 pandemic caused great volatility in the gold market in 2022. Based on our Q4 data, gold was down close to 4% year to date in 2021 but was up 5% in the fourth quarter of 2022, demonstrating increased interest in the asset class with rising inflation concerns. Some investors think gold will start to shine in 2022 as the market digests negative real yields in the face of potential runaway inflation numbers. Analysts from Australian Bank, ANZ, expect gold prices to rally in the first half of 2022 but will come back down later in the year after the expected interest rate hike from the Federal Reserve. Meanwhile, another historical catalyst for gold, geopolitical risks, are on the rise in Ukraine and Russia, Taiwan and China, and domestically due to COVID-19 policies. While the jury is still out on whether the next gold rush will emerge, it is an investment theme we are keeping our eye on going into 2022.

Image from the Gold Rush of 1849. Will we see history repeating itself in 2022?

Cryptocurrency

While the economic results of the COVID-19 pandemic have some investors looking backward to seek inflation protection, others are wondering if a cryptocurrency investment has a portfolio role in the investing looking glass. Crypto has had a varied history and is known to be one of the most volatile assets. However, its use as an alternative store of value and currency (“digital gold”) has been attractive for some investors seeking shelter from potential Federal Reserve money printing and other monetary policies supportive of risk assets. The cryptocurrency market has started 2022 on poor footing with Bitcoin falling more than 7% on January 21^st. This comes after global concerns from emerging regulations on cryptocurrencies in Russia, one of the largest crypto-mining markets. Will this rocky start send Bitcoin tumbling down into a digital mineshaft? Goldman Sachs remains optimistic about Bitcoin’s potential, citing that it thinks the price could double in the next five years, stealing some of gold’s luster in the process. The crypto story will continue to unfold in 2022 and we will be keeping watch with “laser eyes.”

Environmental, Social, and Governance (ESG) Investing

Every day, more and more investors want their investments to not only grow in profitability but also spark positive change in the world around them. The demand for environmental, social, and governance (ESG) investing grew substantially in 2020 with a record 140% increase in investment funds going towards ESG investments. In 2021, investor demand grew further with companies across the planet trying to meet investor preferences through sustainable business practices and policy actions to reduce their carbon footprint. Northern Trust Corporation’s ESG index fund (Ticker: ESG) which invests in large-cap companies promoting sustainability and social governance is up more than 14% from January 2021 to January 2022, with its outlook looking strong. Its $186 million assets under management include a diverse mix of industries such as technology, health care, and renewable energy. As young millennial investors enter the stock market, many believe impact investing will be at the forefront of their minds and their pocketbooks. ESG investing is paving the way for new roads in the market such as carbon investing, green bonds, and clean energy development. We plan to discuss this topic further in the coming months and provide opportunities to put your dollars to work for a more sustainable planet.

Grow your wallet and your planet with ESG Investing

The Looking Glass

“It’s a great huge game of chess that’s being played – all over the world- if this is the world at all you know” – Lewis Carroll in Through the Looking Glass. These words of Carroll from more than 150 years ago still hold in life, especially in the geopolitical and investing realms. From inflation and interest rate concerns to safe-haven capital flows to gold and ethically directed demand for ESG investments, investors must actively survey the chessboard and potentially modify the strategy to win the game. 2022 is sure to challenge us tactically with blockades, decoying, and double attacks. Servant Financial will use a stable, yet flexible looking glass by investing your capital with integrity, compassion, and experience. Follow us as we reflect on these and other topics in the coming year.

One Up On Main Street – A Farmer’s Daughter’s Guide to Farmland Investing

Written November 29, 2021November 29, 2021 by Ailie Carlene Elmore

Author’s Note

“This past month, I defended my master’s thesis on the Role of Farmland in a Mixed Asset Investment Portfolio. Under the direction of Dr. Bruce Sherrick at the University of Illinois at Urbana-Champaign, I explored how an investment in farmland can interact in an investment portfolio of equities, bonds, and treasuries in addition to how it can hedge against inflation. Using data maintained by Dr. Sherrick and courtesy of the TIAA Center for Farmland Research, I analyzed the returns to farmland from 1970-2020 and some of my results are discussed below in addition to introducing farmland as an asset class to institutional and individual investors.” – Ailie

Background on US Farmland

Farmland is a unique asset class in that it has a limited supply and potentially an unlimited useful life. Only 17.2% of the United States landmass is considered arable. With a growing world population projected to reach 9.7 billion by the year 2050, farmland is well positioned as a production source for a basic human need: food. Not only is the population rising but income levels are also expected to follow suit with world GDP projected to double by 2050. These statistics suggest that demand for food is going to go up and the composition of caloric intake is expected to change. Research shows that protein consumption rises with rising income levels. With a significant portion of farmland acres dedicated to either feeding livestock or producing other protein sources like chickpeas or lentils, farmland owners and operators are uniquely positioned to meet this demand and profit from it. So long as humanity needs food, there will be economic rewards for the cultivators and landowners.

Farm Balance Sheet

If an institutional or individual investor was investing in a company’s common stock or buying a corporate bond, they would typically examine the balance sheet of the company. The same is true for investing in farmland. Farmland has grown in value significantly over the last 50 years with a 55% increase in the last 10 years alone. Farmland (Real Estate in the table below) dominated the asset side of the farm sector’s balance sheet encompassing close to 83% of total assets. Under the recent low-interest-rate environment, farmland’s debt level has also grown but this is still significantly less than the portion of farm assets it supports. The overall low debt to equity ratio of 16.2% demonstrates a very conservative leverage position relative to other real asset sectors and the relative strength of the U.S. Agriculture industry as a whole.

Data maintained by the TIAA Center for Farmland Research based on data from the Economic Research Service, a sector of the USDA

Returns to Farmland

Like any real estate asset, farmland receives returns when held by an investor in two ways: appreciation in value and cash flow generated from rental income. In 2021, the U.S has experienced a rise in both. According to the USDA, farmland prices are up 8% from last year. Record sales prices of farmland have been occurring throughout the U. S.’s key growing regions.

August 2021 USDA Land Values Summary

On the rental income side, most investors would be participating in a straight cash rent system meaning a farmer pays the landowner a fixed amount per year for the use of the land. Recently, the U.S. has experienced growth in cash rent values along with the rise in farmland prices. Fueled by strong commodity prices, healthy farming profits, and appreciating land value, cash rental rates are projected to rise 10% in 2022.

To examine a longer-term horizon of historical returns to farmland, data from the TIAA Center for Farmland Research was utilized from the years 1970-2020. During this period, the average return to all U.S farmland was 9.7% with a standard deviation of 6.4%. This composite return encompasses all 50 states. However, not all regions of the U.S. are suitable for farming or have optimal productivity. An institutional investor also has to consider that that are nine anti-corporate farming states that would make it difficult for them to invest in certain key production states like Iowa.

One way for an investor to maximize their potential returns while gaining operational efficiencies from scale is to invest in a farmland fund that provides broad diversification with farms in several key states. The Promised Land Opportunity Zone Fund (“PLOZ” or “Promised Land”) is one way for investors to capitalize on the durable returns of U.S. farmland while also receiving favorable tax benefits such as a reduced capital gain taxes depending on how long the asset is held. The government defines opportunity zones as urban and rural communities that need significant investment to foster economic revitalization. The current PLOZ portfolio is managed by Farmland Partners in conjunction with Servant Financials’ founder, John Heneghan. Currently Promised Land owns 10 properties of 8,000 acres in North Carolina, South Carolina, Illinois, and Mississippi. These states encompass some of the highest performing states in the U.S.

Using this state composite for Promised Land, the weighted average return of states represented in the fund can be used as a proxy to compare farmland returns with other traditional investments. This is done by weighting the allocation to each of the 5 states by purchase price then finding the average return of these states using the TIAA Center for Farmland Research’s data on cropland return. The return from 1970-2021 across the Promised Land proxy states was 11.1% with a standard deviation of 8.4%. Looking at the more recent term, this farmland proxy had a return of 8.2% with a lower standard deviation of 5.2%.

Note: This analysis uses USDA state-level averages to compare historical returns and does not necessarily represent the returns that an investor would achieve with an allocation to the Promised Land Opportunity Zone Fund.

Relationship of Farmland with Traditional Investments

The proxy returns in the Promised Land Opportunity Zone Fund can be compared with other traditional assets such as corporate bonds, stock indices, REITS (real estate investment trusts), treasuries, and gold. Using a risk-return plot under two different time horizons, the position of farmland as an investment can be compared with other investments. Performance metrics from 1970-2020 were examined to show farmland as a longer-term investment compared to a shorter time horizon of 2000-2020. See the figures below for full details.

Data maintained by the TIAA Center for Farmland Research.

The Promised Land OZ proxy demonstrated the highest risk-adjusted return compared to the other asset classes over both time periods. PLOZ has the optimal position in the upper left-hand quadrant of the graph with a high return and overall lower risk compared to equities, REITS, and gold. Even in the last 20 years, the PLOZ proxy still yielded high, relative returns with lower risk.

The relationship between farmland and other investments can be further compared by examining the correlation of returns in the chart below. A value of 1 means two asset classes are perfectly correlated and would be expected to move up or down in tandem. A negative number suggests the two assets move in the opposite direction over time.

Promised Land’s negative correlation with stocks (S&P 500, Dow Jones, NYSE) gives reason to believe that farmland would provide diversification benefits and offset some of the volatility of these assets with high standard deviations (risk measure). In the more recent past (2000-2020), farmland’s negative relationship with stocks is even stronger with a -.32 correlation with the S&P 500. Note that when the S&P 500 dropped 48.6% in 2008 after the great recession, the Promised Land proxy maintained a positive return of 8.9%.

Relationship of Farmland with Inflation

Recently, investors have been concerned about inflation and how they will affect investment portfolios. The Labor Department recently reported that inflation had hit a 31-year high in October with the consumer price index (CPI) rising to 6.2%. Investors and economists across the globe are wondering if we are witnessing the death of Fed’s “inflation is transitory” narrative. Historically, stock indices have had a negative correlation with inflation and investors are concerned that these inflationary trends are long-term and secular in nature. Farmland on the other hand has historically provided a nice hedge against times of inflationary pressure. Examining the PLOZ proxy returns with CPI trends shows a positive correlation of .71, meaning historically an increase in the CPI will also increase returns to farmland. Recently this trend has held as some Midwest land is up 20% in value along with the higher consumer prices. See the figure below for more details.

Investment Opportunities

With its potential return and diversification benefits along with its track record as an inflationary hedge, farmland is positioned well to have a complimentary role in a traditional 60/40 (equity/bonds) investment portfolio. To optimize on this potential, investors have a few different options to partake in farmland investing. The most obvious option is to buy farmland directly. However, this could be costly and comes with the requirement that the investor find capable management for the parcel. Buying a single parcel of farmland also puts the investor at more risk that comes from regional concerns like weather or farm-level (or idiosyncratic) risks like loss of production due to water or soil nutrient levels.

To alleviate some of the parcel management burden while still participate in farmland’s return and diversification benefits could be to invest in the Promised Land Opportunity Zone Fund. The fund is targeting internal rates of return between 8% and 14%, before consideration of the tax benefits it would provide to OZ investors. PLOZ’s mission is to help investors and agricultural communities achieve mutually beneficial outcomes through profitable, durable investing in farmland and the revitalization of rural American communities. In addition to its core “opportunity zone” impact, Promised Land is evaluating other environmental, social, and governance (ESG) principles, such as farmland preservation, wetland and forestland restoration, organic conversions, and soil health and carbon management practices. Promised Land’s vision is for these agricultural communities to prosper by feeding the world while OZ investors do well by doing good for these communities and the environment. If you are interested in learning more about the Promised Land Opportunity Zone Fund, please contact Ethan Rhee at ethan@servantfinancial.com.

Another option for investors would be to invest in Promised Land’s partner: Farmland Partners Inc. Farmland Partners Inc. (FPI) is a publicly traded company that acquires and manages high quality farmland throughout North America. FPI manages the farmland in the Promised Land Opportunity Zone Fund as well. FPI’s current portfolio consists of 157,000 acres in 16 different states. Currently FPI’s stock is trading for just over $12 per share which is up 50% from this time last year. We believe this is an attractive entry point below the fair value of the farmland that FPI owns. On their third quarter 2021 earnings call, CEO Paul Pittman, commented that the net asset value of the farmland was closer to $14-$15 per share. FPI has also restarted its growth and consolidation strategy. In addition to direct farmland acquisitions, FPI is growing its asset management business with its property management arrangement with Promised Land and its recent acquisition of Murray Wise & Associates.

With the risk of secular inflation on the rise and the inherent portfolio diversification, an investment in farmland is something all investors should be considering. By including an allocation to farmland in your investment portfolio, you’ll have a much more efficient portfolio and be “one up on Main Street” investors enamored with a traditional 60/40 investment portfolio.