How Not to Hedge the Coming Inflation Storm

A person holds a visual representation of the cryptocurrency Bitcoin, at the "Bitcoin Change" shop in the Israeli city of Tel Aviv on Feb. 6, 2018. (Jack Guez/AFP/Getty Images)

Commentary

Inflation is running hot and not showing any signs of easing up.

So it’s the Federal Reserve to the rescue. But as usual, they’re late to the party. (I’m actually expecting four rate hikes this year rather than the two to three the Fed has been suggesting.)

A big question on investors’ minds is how high will they push rates, and at what point might that rate hike start to impact stocks overall?

I’ll go out on a limb and say that if the Fed can boost rates to about 50 basis points above the 10-year Treasury Note yield (which also keeps inching higher in response to their QE taper), you might start to see some cracks in the armor of the current bull market. With the 10-year hovering around 1.75 percent these days, that would imply a Fed rate hike to 2.25 percent to set off a selling wave in stocks—a level that’s still a ways off.

The real outlier would be if they increased rates by 50 basis points in any one of their interventions instead of the standard quarter point increase we’re accustomed to. That would really shake things up.

But all this Fed speculation is merely mental gymnastics. Whether they push rates high enough to tank the market 15 or 20 percent is of secondary concern at the moment. What’s critical right now is the fact that our economy is staring down the business end of a double-barreled inflation shotgun.

And this leads to two more questions: How high can inflation actually get before our heroes at the Fed get it under control—and in the face of potentially screaming inflation, what can you do to protect yourself?

Pile into the new, almighty inflation hedge?

Absolutely not—and let me tell you why.

The ‘New’ Gold?

There’s an erroneous belief that bitcoin is the new inflation hedge. It’s nothing of the kind.

The idea behind hedging your currency is abandoning your rapidly devaluing fiat currency for an asset (a real currency) that will hold its value.

Let’s take a deeper look relative to the “old” go-to inflation hedge.

For thousands of years, gold has been considered a “hard” currency because it has all the properties that make for a currency. It was a medium of exchange, a unit of account, and a store of value.

And best of all, it exists in limited supply. For all the alchemist’s efforts, no one could ever figure out how to spin gold out of yarn (much like our Fed does today). So when a fiat currency is threatened by devaluation by a central bank, gold has always been the go-to asset.

Now let’s look at bitcoin.

Bitcoin is a digital “currency” that does promise a strictly limited supply. It doesn’t pay a dividend or offer any other kind of return.

It’s a derivative of nothing whose price is driven predominantly by FOMO.

Yep.

It’s price is driven largely by the fear of missing out—in other words, greed. The spectacular price swings in bitcoin—from near zero to over $1,100 in 2013, then to near $20,000 in 2017, and its all time high above $68,000 in 2021—were all generated by more and more people jumping on board when the currency started to run.

And what else moves like that?

Momentum stocks.

So Bitcoin Is?

It’s a juiced momentum stock.

Bitcoin has virtually no correlation to actual inflation. But what it does correlate to is the stock market. Have a look at the chart below.

BTC (black line) in relation to S&P 500 (red line) since January 2017. (Barchart.com)

In fact, it’s almost impossible to tell from another wildly popular momentum stock.

TSLA (black line) in relation to S&P 500 (red line) since January 2017. (Barchart.com)

Now this is not to say that another 120 years down the road, when all the bitcoin is finally mined, it won’t evolve to become the next great inflation hedge.

But for now, it’s not.

Instead, treat it like the momentum stock it is. Get on board when upside momentum in stocks kicks in, but don’t bet on it to save the day in the face of monster inflation.