NEW YORK ( TheStreet) -- Inflation fears have subsided as the economic outlook has darkened once again. This is boosting the dollar and sending gold prices lower while many observers are pushing the Federal Reserve to take more drastic monetary policy actions to support the economy as a gridlocked Congress stands idle.Even if policymakers overlook the threat of inflation, though, investors shouldn't forget the damage that even low-level inflation can have on their holdings -- particularly at a time when interest rates are at record lows.
I recently heard Steve Mandel, founder of Lone Pine Capital, say at a conference that investing in today's fixed income markets is a "Heads, I win very little/ Tails, I lose very big" proposition. And the estimable James Grant, longtime Wall Street chronicler and the author of the widely respected newsletter Grant's Interest Rate Observer, has called the bond market a "value desert." Investors who are viewing fixed income as a low-risk investment may want to rethink their assumptions in the current climate. Unfortunately, the stock market doesn't seem particularly inviting at the moment either. The global economy is in trouble, with China slowing and the crisis in Europe weighing on the U.S. economic recovery. I'm by no means predicting a double-dip U.S. recession now, but the risk is certainly elevated, and I can understand why investors are wary of buying into stocks after everything that has transpired over the last decade. The good news about stocks is that many strong and steady U.S. corporations are sporting far more attractive dividend yields now than anything you'll find in fixed income without delving into riskier credits. Shares of pharmaceutical giant Merck ( MRK) , for instance, are yielding 4.3%. Questar ( STR), a natural gas utility company in the Rocky Mountain region, yields 3.2%. Exxon Mobil ( XOM) yields 2.7%. Moreover, stocks offer a natural hedge against inflation, since companies tend to benefit from charging higher prices even as they pay higher prices, and the long-term prospects for capital gains on stocks are far more attractive than bonds right now from a valuation perspective. Stocks have certainly proven to be a superior long-term investment throughout modern U.S. history, even during calamitous events like the Great Depression and world wars. If you think we're headed for another train wreck and the stock market is going lower, you can sit in cash and wait for the bottom to buy stocks, but it's hard to thread that needle without a crystal ball or a time machine. And remember, even at a time when the dollar is gaining strength relative to other currencies, it's still losing purchasing power over time at the hands of inflation, which brings me back to my original point.
If anything, government statistics understate the rate of inflation. Most Americans would probably agree that the CPI doesn't reflect the extent to which the cost of living has gone up over the years and their dollars don't buy as much as they once did. And even the official rate of inflation is likely to go higher from here over time. In fact, many widely respected authorities -- from former Fed Chairman Paul Volcker to Berkshire Hathaway ( BRK-A), ( BRK-B)) CEO Warren Buffett -- have warned that the extraordinary monetary actions that are being taken -- and are still likely to be taken -- by the Fed and other central banks around the world raise the risk of higher inflation sooner or later. I wouldn't want my portfolio to be in cash when that day arrives. This commentary is from an investment professional with Clear Harbor Asset Management who is a participant in TheStreet's expert contributor program.