Last week we were worried about rampant inflation with too much government stimulus and this week we are worried that a correction may be underway as a result of not enough government stimulus; this after several weeks of amazing gains.  One thing is for sure, no matter what happens, we are going to be worried about something. 

The recession is far from over.  We are going to get more bad news which will continue to send jitters to the markets around the world.  If any correction is underway, it is normal after such a sharp and fast run up.  If you remember, no one anticipated the markets to start turning around before fall 2009 or even 2010.  This was a very fast run up after the deepest drop in a decade.  I think it is likely that we will see a very volatile summer and some drops before the recovery continues.  The markets never go up in a straight line , but again no one knows for sure.  Thus the importance to remain calm and focused.  Warren Buffet says that the number one reason for his investing success is his emotional stability.

In any event, the biggest threat, the one we must plan for, is inflation.  That is much more of a threat than a few more months of volatility.

As the governments around the world, especially the US, continue to pump money into the economy, some inflation is inevitable. Most economists don’t expect inflation to arrive anytime soon. But nobody really knows when it will appear or how bad its effects will be. In the meantime, we are suggesting that investors make sure that their portfolios are well positioned to w eather the impact of inflation to come.

We don’t see inflation as a problem this year and even perhaps for 2010, and some deflation is more probable in the short term. But inflation is a factor that we need to plan on. That doesn’t mean making radical changes to your investment portfolio. It means incorporating some classic inflation hedges—like commodities, real estate and making sure your fixed-income investments have relatively short maturities.

We recommend shorter-term fixed-income investments, because bonds with long maturities are most affected by rising interest rates.  Bonds can be a disaster in inflationary times.  People think that bonds are safe and can’t suffer a loss. This is wrong.  When interest rates rise, bond market value drops.  The longer the bond term, the bigger the drop. It can be quite shocking to see your “safe” investment drop in value.

It is also time to add commodities to your portfolio.  Commodity investments tend to perform well when there’s inflation because rising prices usually mean a stronger economy. That leads to increasing demand for raw materials to meet rising production and consumer needs. Don’t be tempted to make individual bets on oil or gold. Instead, buy a diversified basket of commodities.

We suggest 5 to 10 percent of a portfolio in commodities. Given commodities’ volatility, investors need to rebalance their portfolio periodically to make sure their position doesn’t balloon.

Real estate can also be a good way to hedge against inflation. Real estate investment trusts, which invest and own commercial and residential properties, are an easy and liquid way to gain access. Not surprisingly, REITs, which are required to distribute most of their income (generally from rent rolls) to shareholders, have been battered in the downturn. But they have shown signs of hitting bottom, and might be a good time to start building a position.

If you did not see us recently for a review, you will be receiving a portfolio review in the mail.  We want to ensure that your portfolio is well positioned for the recovery and inflation down the road.