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Inflation is at a four-decade high, could a recession be next?

Kitco News

(Kitco News) - Inflation is now at yet another four-decade high, with the headline consumer price index surpassing (CPI) December's reading of 7% to reach 7.5% in January, according to the latest data release from the Bureau of Labor Statistics.

All eyes are now on the reaction of the Federal Reserve. Michelle Makori, editor-in-chief of Kitco News, discussed likely responses from the U.S. central bank, as well as the assets that will benefit most from a high inflationary environment, with Mike Lee, founder of Mike Lee Strategy, and David Nelson, chief strategist of Belpointe Asset Management LLC.

"I definitely think we're going to get 50 basis points [of rate hikes] in March," said Lee.

Nelson said that several rate hikes are now priced into the markets.

"Right now, what you're seeing price in is 200 basis points by the end of the year," he said.

However, raising the Fed Funds rate may not be enough to combat inflation Lee said.

"I don't know what raising rates is actually going to do for inflation, other than home prices. It's not going to affect rents, it's not going to reduce a gallon of milk, it's not going to make oil prices go down. You're so far away from taking real liquidity out of the economy vis-à-vis the Fed Funds rate," Lee said.

Lee added that inflation has likely already peaked.

"If we're not at peak inflation now, we will be in the next couple of months, mostly because of the demand destruction and lower base effects," Lee said. "If inflation continues to accelerate, you now are running into a real societal problem. Governments in countries like Argentina have been toppled because of this."

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Nelson noted that supply chain issues are not the only part of the inflation equation.

"To me, the heart of it…you've got to look at the prices of energy," he said. "Energy touches every line item of the income statement, and it's not just at the corporate level, it's in everybody's pocket book."

However, even with tightening monetary policies, a recession is not likely to hit right away, according to Lee.

"My concerns of a recession are close to zero in the next couple of years. Recessions are caused by debt bubbles, we don't have your classical debt bubble of a financial crisis…credit spreads have not blown out, high yield spreads have not blown out, and if you look at the Chicago Fed national liquidity index, you really haven't seen meaningful tightening of financial conditions yet. All this can change in six months from now, a year from now," Lee said.

That's not to say that a recession is impossible, especially if the inflation problem exacerbates.

"I think we're in a bit of no-man's land, bouncing around, a lot of volatility. I think this inflation is bad. I think if it doesn't come down dramatically over the next six months, you can be looking at more than just the House and the Senate flipping to Republican. There definitely is a probability that inflation accelerates and not decelerates, so, if that sort of thing does happen then yes, a recession or possibly worse is on the horizon," he said.

Nelson said investors should energy companies are one sector that will likely benefit from inflation.

"There's a reason why energy companies have been the best performing companies last year, they've been the best performing companies this year. Even if oil prices stay where they are right now, the cash flow is there. The average energy company out there is probably trading at a single-digit P/E, a free cash flow range seven to nine percent at a three percent dividend. In a market that is trading at over twenty times [P/E], that's probably a good place to hide," Nelson said.

In addition, investors should avoid highly speculative investments in this environment.

"Financials can do well, but they need more than just rates going higher. The fact that the yield curve is starting to revert, that's problematic. Also, they're starting to be attacked by fintech as well. [JPMorgan CEO] Jamie Dimon said that fintech is their biggest, biggest concern over the next couple of years. Energy, right now, materials, you're just going to have to do your homework," Nelson said. "Even in tech, you can find companies trading at respectable multiples and reasonable growth rates, you don't have to buy into a company that has zero earnings."

Lee also likes the energy sector as an investment.

"Biggest position is in energy, as David said. If you think about energy as a sector, all the wind is at its sails. You still have an economy that's coming back online and if you go back to the summer of 2020, the story with this economy is that it's coming back with growth and the resurgence of the economy has just been better than anyone imagined," Lee said.

For more information on investments to consider during a high inflationary environment, or how escalating tensions in Eastern Europe could move markets, watch the video above.

Follow Michelle Makori on Twitter: @MichelleMakori

Follow Kitco News on Twitter: @KitcoNewsNOW

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.