The Path to Profit in Inflation: How Investors Can Master the Golden Rules of Asset Allocation

As central banks repeatedly announce interest rate hikes and the prices of goods in supermarkets keep rising, many investors are beginning to feel anxious—what does inflation really mean? How will it change our investment strategies?

In fact, inflation is not only a risk but also an opportunity. The key lies in understanding its mechanism and choosing the right asset allocation.

The Essence of Inflation: Why Is Investing Especially Important Now?

Let’s first break down the core definition of inflation. Simply put, inflation is a period during which prices continuously rise, leading to a decline in the purchasing power of cash—your money is shrinking. The most commonly used indicator to measure this phenomenon is the CPI (Consumer Price Index).

But a deeper question is: Why does inflation occur?

Economics tells us that the fundamental cause of inflation is the money supply exceeding the economic output, meaning too much money chasing too few goods. This imbalance can stem from several factors:

Demand-pull inflation: When demand for goods increases, prices go up, and corporate profits rise. Profits lead to more consumption and investment, further stimulating demand, creating a positive feedback loop. Although this demand-driven inflation pushes prices higher, it also results in GDP growth—governments worldwide see this as a positive and allow it to develop.

Cost-push inflation: Rising raw material or energy prices can also trigger inflation. During the Russia-Ukraine conflict in 2022, Europe’s energy supply was disrupted, causing oil and gas prices to surge tenfold, and the Eurozone CPI annual rate exceeded 10%, hitting a record high. Cost-push inflation tends to lower overall output, leading to a decline in GDP.

Excessive monetary issuance: Unrestrained money printing by governments inevitably leads to hyperinflation. Taiwan in the 1950s experienced a situation where 8 million old dollars were only worth 1 US dollar.

Self-fulfilling expectations: When people anticipate higher prices in the future, they buy in advance and demand higher wages, prompting businesses to raise prices, forming a inflation spiral. This is the hardest to break and is a key area central banks focus on preventing.

Central Bank Choices: How Do Rate Hikes Change Investment Dynamics?

In response to high inflation, central banks often resort to raising interest rates. Raising rates seems simple but actually reshapes the entire investment ecosystem.

After rate hikes, borrowing becomes more expensive. For example, a loan interest rate that was 1% might rise to 5%. Borrowing 1 million, the annual interest jumps from 10,000 to 50,000. Ordinary people are less willing to borrow for consumption and instead deposit money in banks. Market demand weakens, businesses are forced to lower prices to stimulate sales, ultimately reducing price levels and curbing inflation.

But what is the cost? Business demand decreases, hiring plans shrink, unemployment rises. Economic growth slows or even enters recession. That’s why rate hikes are considered the central bank’s “last resort”—they can curb inflation but may also damage the entire economy.

Key Insight: Moderate Inflation Is Beneficial to You

Here’s a counterintuitive fact: 2%-3% moderate inflation is actually healthy.

When people expect future goods to be more expensive, they buy in advance, boosting demand and driving business investment and expansion, which enhances economic vitality. China in the early 2000s proved this—CPI rose from 0 to 5%, and GDP growth jumped from 8% to over 10% during the same period.

The opposite example is Japan. After the economic bubble burst in the 1990s, Japan fell into deflation (CPI negative), with people preferring to save rather than spend, and GDP growth turned negative—marking the start of the “Lost Thirty Years.”

For this reason, major central banks like those in the US, Europe, and Japan set their inflation targets at 2%-3%.

Another secret about inflation: those with debt actually benefit.

Inflation erodes cash value, but if you are a borrower, the situation is reversed. For example, 20 years ago, borrowing 1 million to buy a house with 3% annual inflation means that after 20 years, the debt is only worth about 550,000—meaning you only need to repay half the original amount. This is why, during high inflation periods, leveraging assets like stocks, real estate, and gold yields the highest returns.

High Inflation and the Stock Market: From Risks to Opportunities

Many worry that high inflation will destroy the stock market, but the truth is more complex: low inflation benefits stocks, while high inflation exerts pressure.

In a low inflation environment, market liquidity is abundant, and hot money flows into stocks, pushing prices higher. Conversely, during high inflation, central banks raise interest rates, increasing corporate financing costs and depressing stock valuations.

The 2022 US stock market is a textbook example: CPI surged 9.1% year-over-year to a 40-year high, the Fed raised rates seven times in one year totaling 425 bps, pushing rates from 0.25% to 4.5%. The result was a 19% decline in the S&P 500 and a 33% plunge in the tech-heavy Nasdaq.

But this does not mean you should sell all stocks during high inflation. Historical data clearly shows that energy stocks often outperform during high inflation periods. In 2022, the US energy sector returned over 60%, with Western Petroleum up 111% and ExxonMobil up 74%.

Why? Energy companies benefit from rising oil and gas prices during inflation, and their earnings growth offsets valuation pressures caused by rate hikes.

Asset Allocation Framework in an Inflation Environment

Having understood how inflation works, how should investors respond? The answer is diversified asset allocation.

The following assets tend to perform relatively well during high inflation:

Real estate: During inflation, abundant money supply often flows into the real estate market, driving up property prices.

Precious metals (gold, silver, etc.): Gold prices are inversely related to real interest rates (nominal rate minus inflation). The higher the inflation, the more likely real interest rates are negative, increasing gold’s appeal as a hedge.

Stocks: Short-term performance varies, but long-term returns usually outpace inflation, especially in sectors like energy and healthcare that are resistant to economic cycles.

Foreign currencies (e.g., USD): During high inflation, the Fed adopts a hawkish rate hike strategy, causing the dollar to appreciate, making it an effective inflation hedge.

A feasible allocation plan is: evenly distribute funds among three asset classes—33% stocks (especially energy stocks), 33% gold, and 33% USD. This approach leverages stock growth potential, gold’s value preservation, and dollar appreciation, effectively diversifying risk.

Practical Operations: How to Quickly Build a Diversified Portfolio

Theoretically perfect, but execution is often a bottleneck. Traditional methods require opening accounts with multiple brokers and futures firms, which is cumbersome. CFD (Contract for Difference) platforms offer a one-stop solution.

Through CFD platforms, investors can trade stocks, gold, forex, cryptocurrencies, and more within a single account, with leverage up to 200x, greatly reducing trading costs.

For example, investing in gold with 100x leverage requires only $19 to control a standard gold lot, which is very friendly for retail investors with limited capital. The same applies to trading USD indices or energy stocks (like ExxonMobil)—just input the relevant code in the search box to quickly open a position.

Summary

Inflation is a normal part of modern economies, not an anomaly. Low inflation promotes economic growth, while high inflation requires central bank intervention. Raising rates can curb inflation but may trigger recession.

As an investor, the key is not to fear inflation but to understand its mechanisms and choose the right asset allocation. In an inflationary environment, a diversified mix of stocks, gold, and USD can effectively hedge risks and seize growth opportunities.

Remember: in times of inflation, the right asset allocation determines whether you passively suffer depreciation or actively earn returns.