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The stock market continued its winning ways for most of February as complacency set in even in the face of major headwinds such as unrest in northern Africa and the Middle East and continued job and housing weakness at home.  Finally during the last week of the month and into the first trading day of March the fundamental threats caught up with the market and sent stocks down sharply.

For well over a year now I have been warning of the dangers of inflation, currency debasement, budget deficits, bailouts and the like.  Investors might want to consider building positions in gold and other complementary areas for both protection as well as the potential reward.  For me, at first this was a major departure from my bread and butter strategy of owning quality stocks at reasonable valuations.  I felt that it was necessary, however, to protect mine and my investors’ capital from the aforementioned forces.  Recently I have decided to take this approach to an even higher level.
 
While I had been preparing for severe inflation with a portion of the capital that I control, it was business as usual for the majority of it.  This month I changed course because I made the decision to give greater appreciation for the potential of the economy’s inflationary dilemma to wreak havoc.  While I am confident that there will be a major inflation problem (indeed inflation has already arrived as is evident in food, energy and other commodity prices), I cannot predict with certainty the severity level.  I want to be prepared, however, for the worst-case and most extreme possibilities.  I am consciously attempting to overcome the natural human inclination to assume that things will simply work themselves out. 
 
Bonds should be a poor investment in highly inflationary times, while the real purchasing power of cash wastes away.  If the inflation is bad enough, stocks too may not provide cover as profit margins erode and the market further penalizes them by placing lower valuation multiples on those earnings.  In such a scenario, direct inflation investments could be the only safe place to be.  The good news is that they possess the potential to perform extraordinarily well.  And even if the inflation is somehow more manageable, these investments should still outperform a broad equities portfolio.
 
Michael H. Berlin, CFA, CPA, is the founder and portfolio manager of MHB Equity Partners, a value-oriented private investment partnership.  He previously worked at Lehman Brothers, and before that at Ernst & Young.  Mr. Berlin holds an MBA from Columbia and a BBA from Michigan.
 
The information included in this article is not intended to be used as a basis for making investment decisions nor should it be constructed as a recommendation to buy or sell any specific security. Consult your investment professional for additional information and guidance.
 
 
Michael can be contacted at mberlin@mhbpartners.com and at (631) 629-4928.