Just when you needed something else to worry about: Inflation isn't dead.But, hey, I've got good news, too. I've found a way that you can make more money from inflation and lower the risk from inflation in your portfolio at the same time.
Diversify into infrastructure stocks. I'd go so far as to call them "the new gold."
According to the producer price index numbers released March 15, inflation isn't dead. The headline index of inflation at the wholesale level climbed at a 2.5% rate in February. That's not good news, since future inflation at the consumer level often follows the wholesale trend with a lag of six months or so. An annual 2.5% rate is certainly high enough to make the
nervous about cutting interest rates, as Wall Street hopes it will in the months ahead.
In a normal financial market, I'd advise adding to positions in gold and other commodity stocks as a hedge against inflation. The prices of the underlying commodities typically go up when inflation climbs, and the stocks of commodity producers climb even faster, since their earnings rise faster than the prices of the commodities themselves. That's because the costs at these companies are largely fixed, so increases in commodity prices drop straight to the company's bottom line.
Not Business as Usual
But this isn't a normal financial market. Because the 416-point selloff of Feb. 27 was largely a result of traders unwinding speculative positions purchased with borrowed money, the prices of gold and other commodities didn't zig when the stock market zagged, as they usually do. Instead, since traders were also selling speculative positions in gold and other commodities, shares in these sectors went down along with everything else.
I'm a long way from abandoning gold and other commodities as hedges against inflation. The selloff in this sector seems to be over, and the price of at least one commodity, copper, is on the rise. So I'm going to stick with my commodity stock plays:
( AAUK) and
-- especially because these stocks are also good hedges against the long-term downward trend in the U.S. dollar.
But it's time to re-examine the assumptions behind portfolio diversification. The unwinding of global leverage and the re-pricing of risk in the asset markets that started on Feb. 27 is a long way from over. Investors who want to take some of the risk out of their portfolios by diversifying into asset classes that will go up when everything else goes down need some new tools.
For the next decade, at least, I think investors should think of infrastructure stocks when it comes to hedging against inflation.
I started to think about the infrastructure sector -- the stocks of companies that make the raw materials for building roads, ports, rail lines, airports, etc., that do the actual design and construction work on those projects and that raise the money for these projects -- when I read reports on the Indian and Brazilian economies, both issued almost simultaneously, calling for massive new investments in infrastructure to increase economic growth and to fight domestic inflation.
Increasing growth by building roads and other infrastructure projects has been a standard tool of governments at least since the days of the Qin emperor who started the Great Wall of China in the third century B.C. Spending on infrastructure creates jobs that lead to more economic demand that creates yet more jobs. So that part of the dual announcements wasn't especially surprising.
A New Tool
But the notion that building infrastructure was a way to fight inflation? Now that was an interesting wrinkle to someone looking for new tools to use in diversifying a portfolio.
The report on the Brazilian economy from the World Bank came out in early March. If Brazil wants to grow faster without a huge increase in inflation, the country must increase investment in infrastructure to 3.2% of Brazil's gross domestic product ($492 billion in 2006) from the current 1% rate.
The government of President Luiz Inácio Lula da Silva has promised to deliver 5% economic growth in the president's second term, which began in October, up from 2.9% growth in 2006. The government's plan calls for an additional 0.5 percentage point of GDP, for a total of 1.5%, to be spent on infrastructure projects. That's clearly inadequate if you follow the logic of the World Bank report, which says that adding 4 percentage points of annual GDP growth would require infrastructure spending of 5% to 9% of GDP. You do the math.
Investors and government planners don't need to imagine what will happen in Brazil if the country doesn't make the investment in infrastructure. They just need to look to India, where decades of underinvestment in roads, ports, airports and rail lines are a central cause of the inflation now at a two-year high of 6.7% and running out of control in the country.
Take a look at the agricultural sector of India's economy to see the connection between infrastructure and inflation. While inflation in the economy as a whole is running at more than 6% annually, inflation in food prices is at 11%. Some of this inflation can be blamed on short supplies of foodstuffs such as wheat and pulse, the legume that plays a central role in the Indian diet. A terrible wheat harvest in Australia caused by drought has driven up wheat prices around the globe.
A Lesson From India
But much of the country's soaring rate of inflation in food prices is self-inflicted. Somewhere between 30% and 40% of the country's crops rot in the fields or spoil in transit because of the country's creaky infrastructure. There simply isn't any way to get the food to market in time. What does make it through the supply chain is subject to huge markups at each stage of the process, because getting food from warehouse to distribution center to retail store to consumer is so time-consuming and cumbersome.
Consumers pay twice as much for wheat, for example, than do wholesale buyers. That adds another layer of inflation to food prices at a time when food inflation doesn't need any help in running wild: Wholesale wheat prices jumped 54% between April and November 2006.
Agriculture isn't the only sector of the economy paying the price. On overcrowded highways, speeds average less than 20 mph. Major cities in some Indian states cut power to factories one day a week. Ships have to be unloaded manually and cargo manually loaded onto trucks. Getting cars the 900 miles from the factory to the port at Mumbai takes one automaker 10 days.
India spends just 4% of its gross domestic product on infrastructure in comparison with the 9% spent in China. That disparity has existed for more than a decade. As a result, while China has 25,000 miles of expressways, India has just 3,700 miles.
Facing what amounts to a rebellion by the rural poor over soaring food costs that is likely to cost the ruling Congress Party power in New Delhi, the government budget released in March promises to tackle the infrastructure part of the problem by raising spending on roads, bridges, airports, etc., by 40%. But the government isn't stopping there: It is promoting public-private partnerships on infrastructure projects that are projected to invest $300 billion to $500 billion over the next five years.
The lesson from India is simple: The faster a country grows, the more it needs to invest in infrastructure so that growth won't send prices rocketing out of control. Once inflation has reared its ugly head, the need for infrastructure investment becomes even more pressing. It's not an overstatement to say that the faster the growth, the faster the increase in the rate of growth of infrastructure spending.
Economic growth, please note, will not only push up spending on infrastructure at a rate to match the growth in the economy, it will increase the rate of increase in that growth rate as governments try to avoid the kind of inflationary bottlenecks now rocking India.
So how do you diversify your portfolio by adding this kind of anti-inflation hedge? Let me count the ways:
- You can add the shares of companies that make the stuff that goes into roads, ports, airports, etc. One stock that fits this category is Cemex (CX) - Get Report, a global cement producer founded in Mexico in 1906.
- You can add the shares of companies that design and build infrastructure projects. One stock that fits this description is Chicago Bridge and Iron (CBI) .
- You can add the shares of the companies that finance this global infrastructure buildup. India, for example, can't afford to pay the bill for its infrastructure needs out of government funds since the country's budget already runs deep in the red. Private investors will have to put up a big part of the cash. Macquarie Infrastructure Company Trust (MIC) - Get Report is one example of a company that invests in and operates infrastructure businesses ranging from airports to bulk storage terminals. The trust is managed by Australia's Macquarie Group, which manages $38 billion in more than 90 infrastructure projects around the world. The shares of the trust pay a 6.3% dividend yield.
New Developments on Past Columns
10 Stocks for the Future: After hitting a high of $56.12 -- about $2 a share above my purchase price -- on Dec. 27, shares of
have moved steadily in just one direction: down. No secret about why. The troubles in the subprime mortgage market have raised fears of a broad-based decline in the real estate market.
And Tejon Ranch's major asset is land, the 250,000 acres the company owns 60 miles north of Los Angeles on Interstate 5. Still, you have to wonder if sellers aren't over-reacting. Permitting (what's called "entitlement") on the two residential communities the company is developing -- Centennial (12,000 acres in Los Angeles County) and Tejon Mountain Village (28,000 acres in Kern County) -- is still 15 to 24 months away.
So land prices are likely to have bottomed and recovered by the time the company actually gets around to selling anything. In the meantime, the 17% selloff from Dec. 27 to March 13 has lowered the price that investors in the stock pay for a developable acre of land from $7,000 to about $5,800. Think that land only 60 miles outside of Los Angles and smack dab on Interstate 5 might be worth a bit more than that per acre?
So hang in. This one will pay off in the long run. As of March 20, 2007, however, I'm lowering my target price to $52 a share by October 2007 from the prior target of $65 by July. (Full disclosure: I own shares of Tejon Ranch in my personal portfolio.)
At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Anglo American, BHP Billiton, Goldcorp, Kinross Gold and Tejon Ranch. He did not own short positions in any stock mentioned in this column.
Jim Jubak is senior markets editor for MSN Money. He is a former senior financial editor at Worth magazine and editor of Venture magazine. Jubak was a Bagehot Business Journalism Fellow at Columbia University and has written two books: "The Worth Guide to Electronic Investing" and "In the Image of the Brain: Breaking the Barrier Between the Human Mind and Intelligent Machines." As an investor, he says he believes the conventional wisdom is always wrong -- but that he will nonetheless go with the herd if he believes there's a profit to be made. He lives in New York. While Jubak cannot provide personalized investment advice or recommendations, he appreciates your feedback;
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