Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / How Inflation Changes Your Investment Risk Profile
Transcript
- Lucas: If our money conversations have helped you think about a decision differently, we deliberately don't run ads on these shows to keep that focus pure. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. Luna: Thanks for keeping it clean. It makes the hard stuff easier to hear. Lucas: Let's get back into it. Look at the S&P 500 right now, hovering around seven thousand seven hundred seventy-three. On the surface, that’s a bull market. But if you look at the underlying mechanics, specifically how inflation is changing the cost of capital, that number starts to feel a lot heavier. Luna: Right, because the denominator in every valuation model is the discount rate, which is tied directly to those rates. Lucas: Exactly. And here is the concrete thing I want us to drill into today: how your personal risk tolerance needs to shift when the Fed Funds effective rate sits at three point seven five percent while core PCE remains sticky at one thirty point five. Most investors are still building portfolios as if interest rates were zero, but they aren't. Luna: So we need to talk about the gap between nominal returns and what actually buys you groceries next year. Lucas: Precisely. Let's look at the ten-year breakeven inflation rate, which is currently sitting at two point three six percent. That number tells us what the market thinks inflation will be over the next decade. But here is the problem: if your safe assets, like short-term Treasuries, are yielding less than that, you are losing ground even before taxes. Luna: It feels like we're trapped between cash losing value and bonds offering barely enough to cover it. Lucas: That is the trap. And this is where most people make the fatal error of chasing yield in risky areas. They sell their safe bonds to buy high-yield corporate debt or speculative tech stocks, thinking they are beating inflation. But they are actually just taking on unnecessary credit risk. Luna: Because those companies might not survive if the economy slows down further. Lucas: Exactly. Think about the current environment in October 2026. We have the Dow at fifty-one thousand two hundred ninety, but the Russell twenty small caps are struggling at two thousand eight hundred fifty. The spread between large cap stability and small cap volatility is widening because smaller firms rely more on floating-rate debt. Luna: So inflation hurts them twice, through costs and through borrowing expenses. Lucas: It does. And this brings us to the first actionable shift: duration risk. When inflation is sticky, long-duration bonds get crushed. But many retirees still hold forty or fifty percent of their fixed income in thirty-year Treasury bonds. That is a massive mismatch for this specific economic cycle. Luna: They’re locking in low yields while prices rise, leaving them exposed to reinvestment risk later. Lucas: Spot on. The smarter play isn't necessarily to dump bonds entirely, but to shorten the duration. Moving from a twenty-year bond to a two-year note reduces sensitivity to rate changes. You might earn slightly less total yield over time, but you preserve capital better when the FOMC keeps tweaking rates. Luna: It’s about liquidity and safety, not maximizing the top-line percentage. Lucas: Right. Now let's pivot to equities. This is where it gets tricky. With the NASDAQ up two point three percent recently, driven by big tech, there is a temptation to load up on growth stocks. But growth stocks are incredibly sensitive to the discount rate. Luna: Because their profits are far in the future, so they get discounted more heavily. Lucas: Correct. If the ten-year yield stays elevated due to sticky inflation, those future cash flows lose present value. This is why value stocks, which generate earnings now, often outperform during high-inflation periods. We see this pattern repeat. Companies with strong free cash flow today beat companies promising huge cash flow ten years from now. Luna: So instead of betting on the next big AI breakthrough, we should look at boring, profitable businesses. Lucas: Boring is exactly the word. Think about industrial conglomerates or established energy infrastructure. These entities have pricing power. When input costs rise, they can raise prices to customers without losing volume. That ability to pass on costs is the ultimate hedge against inflation. Luna: It’s basically a built-in tariff on your own portfolio. Lucas: A very useful one. However, there is a limit. You cannot price your way out of demand destruction. If consumers stop buying because their wages haven't kept up with the CPI, which hit three hundred thirty-four in August, then even those companies face trouble. Luna: Which means we have to watch consumer behavior, not just corporate margins. Lucas: Always. And this leads to the second major shift: international diversification. Many US investors are too home-biased. But look at the headlines coming out of Brazil. Stocks jumping on political clarity. Emerging markets often have higher inflation initially, but their central banks react faster. Luna: They hike rates aggressively to protect their currencies, which can create attractive entry points for foreign bonds. Lucas: Yes. If you hold only US assets, you are betting everything on the dollar staying strong. But with the Fed Funds rate at three point eight eight percent, the dollar is expensive. That makes exports harder and imports cheaper, which helps US consumers but hurts multinational earnings. Luna: So having exposure to other currencies acts as a natural hedge against domestic policy errors. Lucas: It does. And speaking of policy errors, let's talk about gold. Gold futures are at four thousand one hundred fifty-seven. It’s down slightly recently, but over the last decade, it has consistently tracked real yields. When real yields go negative or flat, gold tends to rise. Luna: It’s not a yield-bearing asset, so it shines when paper money loses credibility. Lucas: Exactly. A small allocation, maybe five to ten percent, can stabilize a portfolio during sharp inflation spikes. It doesn't pay dividends, but it pays in peace of mind when the S&P 500 drops twenty percent due to a rate shock. Luna: Peace of mind is a tangible return when you’re trying to sleep at night. Lucas: Now, let's address the elephant in the room: real estate. With mortgage rates tied to those longer-term yields, affordability has taken a hit. But REITs offer a different angle. They provide income and potential appreciation, though they are also sensitive to interest rates. Luna: Especially the ones reliant on refinancing commercial properties that are underwater. Lucas: True. So stick to residential or healthcare REITs. They have shorter lease terms, meaning rents can adjust upward quickly to match inflation. Commercial office space is a different story entirely, and many investors are still holding onto those assets hoping for a rebound that isn't coming. Luna: It’s a classic case of sunk cost fallacy driving bad investment decisions. Lucas: Undeniably. So, to summarize the shifts: shorten your bond duration to protect capital, favor value equities with pricing power over speculative growth, consider international diversification to hedge currency risk, and use gold as a stabilizer. These aren't radical moves, but they are necessary adjustments for the current reality. Luna: It’s about adapting to the new normal rather than fighting the old one. Lucas: Exactly. The market gives you what you bring to it. If you bring a zero interest rate mindset to a three-percent world, you will get punished. If you bring flexibility and awareness of real yields, you can actually grow your purchasing power. Luna: I guess the question is whether we are willing to change our habits before the market forces us to. Lucas: That is the million-dollar question. Because waiting until the next recession hits usually means you’ve already lost half the battle. Luna: Better to adjust the sails while the wind is blowing, rather than waiting for the storm. Lucas: Well said. Thanks for listening.