Dealing with inflation from an investor’s perspective
DIS and DAT
Our periodic communication that reminds you to ask, “Should I react to those headlines?”
April 2022
Dealing with inflation from an investor’s perspective
“Inflation is a form of hidden taxation which it is almost impossible to measure.” John J Beckley
While there exists a lot of uncertainty and change in global events at any given day, one area currently takes up more than its fair share of real estate in the minds of the economy- and money-conscious: inflation. Many reports and much advice on the subject offer varied perspectives. So, in this edition of DIS and DAT, I’d like to jump into the dialog with an investor’s perspective on the inflation.
Increasing inflation means increased anxiety for consumers. Rising values in the popular measure of inflation, CPI, eventually provokes voters to call upon their elected officials to fix the problem. In turn, those officials respond by taking the easy way out.
They raise interest rates.
Increased interest rates lead to a higher cost of capital for business managers. As a result, businesses that must borrow at higher rates will either become less profitable or experience a net loss. Therefore, in inflationary times, we want to hold high-quality businesses in our investment portfolio, and we want to invest in these businesses at attractive to highly attractive prices. Inversion of these two desires means avoiding low-quality business especially at high prices.
What might a high-quality business look like?
A high-quality business would exhibit a substantial competitive economic advantage. In reaction to inflation, it would seek to raise prices, maintain low production costs, or achieve a favorable cost of capital. The great ones can do all three.
Additionally, these businesses would have a highly engaged manager at the helm, preferably one who possesses a business owner’s mindset.
Most importantly as we search out new opportunities in which to deploy investment capital, we must be selective and patient. The marketplace for high-quality businesses is competitive. In other words, many smart people who control large sums of capital are also looking for great investment opportunities. While the opportunities may be few, the opportunistic investor must always be prepared for a period where the mass of market participants become confused and scared. In this panic, there can develop a herd mentality where both high-quality and low-quality businesses can be purchased at significantly lower prices. All combined, this is not an easy task.
“Its not supposed to be easy. Anyone who finds it easy is stupid.” Charlie Munger
We believe achieving the right mindset to pull off this difficult task is important and avoiding some activities could greatly improve one’s “investor’s mindset.” The following is a list of activities that may be popular, but we don’t believe are beneficial in the investor’s mental war against inflation.
- Attempting to predict the random dance of inflation
- Trading heavily in and out of asset classes, sectors, industries, geographies, or individual investments
- Gathering opinions on investments so that we may invest in a comfy consensus
Another factor that makes this task so difficult is that feelings of loneliness, humiliation, and stupidity are required to take advantage of any investment opportunities. Such feelings come along with investing in opportunities that others following the herd mentality may not view as beneficial. If the investor is correct on their investment choices, however, then those feelings will prove temporary. If the investor proves incorrect on their judgement, then those feelings will become permanent realizations.
Avoiding permanent realizations of loneliness, humiliation, and stupidity is a powerful motivator! And so back to work for us.
Thanks for your attention, I hope this helps, and please be safe,
James
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