Make no mistake about it: Inflation is coming. That presents income investors, in particular, with some major challenges, because the level of inflation that I anticipate is coming will be higher than the yields investors can get on bonds, CDs, or virtually any fixed-income instrument.

Or to put it in economist-speak, real rates – the difference between interest rates and inflation – will be negative.

This means that the only way income investors can beat inflation is to own high-yielding investments that are likely to raise their dividends faster than inflation is rising. The best way to accomplish that hat trick is to own stocks that are direct and leveraged beneficiaries of inflation. In other words, if you can’t beat ’em, join ’em. We offer two of the best choices below.

But actually it isn’t just income-oriented investors who should be grabbing stocks leveraged to inflation. All investors need them, because inflation could get really bad, a lot worse than almost anyone is expecting.

When real rates are positive, it’s an incentive to save. That’s because in saving, you sock away the difference between inflation and the interest your money is earning. These savings add to consumers’ sense of well-being, always good for the economy, while providing a pool of funds that can be lent to companies, spurring economic growth.

By raising rates to levels higher than inflation, it would seem the Fed would have a surefire recipe to slow down the economy while at the same time building for the future by promoting additional savings.

The problem is that the bottom 60% of Americans spend virtually their entire income on food, transportation, housing, health care, and taxes. That means that at the end of the day there is nothing left to save.

Dragged Down by Debt

The upshot is that positive real rates are not a boon but a drag, and potentially a crippling one. After decades of steady increases, consumers in the wake of the 2008-09 recession cut back on their debt levels. That trend did not last. Today by any measure – nominal debt, debt to income levels, or anything else – household debt, at over $15 trillion, is at record levels.

When real rates are positive, it means interest rates are rising faster than wages or income. Paying the interest on debt, never mind paying down the debt, becomes ever harder. The mass of consumers, who are saving next to nothing to begin with, have no choice but to go further into debt to service the debt they already have.             

To use another term economists employ, it’s a vicious circle – defined as a situation in which the only recipe for solving a problem, in this case, taking on more debt, is something that makes the problem even worse.

The outcome would be a recession, perhaps a catastrophic one. If the Fed opts to keep real rates positive, we could even see a replay of 2008. That’s why we expect that the Fed will likely keep interest rates lower than inflation.

Another Vicious Circle

Unfortunately, negative rates are hardly a great solution. It means that consumers faced with rising prices will tend to buy more in the present to avoid even higher prices in the future. The result is an economy that speeds up and in the process consumes more resources. It’s another vicious circle, except that this time, rather than incomes going down because of debt, it is inflation that goes up and up.

I am betting that the Fed has learned from 2008. It will not overreact to high inflation, especially if inflation is driven, as I expect it will be, by rising commodity prices. Indeed, rising commodity prices are as much front and center in the inflation thrust as are high debt and low savings.

That points to how investors can beat inflation: by buying commodity stocks – which by definition are leveraged to commodity-engendered inflation – that have decent yields and a history of growth in both dividends and earnings. There are a decent handful that fit the bill, but two that stand out in particular are Rio Tinto (NYSE: RIO) and Glencore (OTC: GLNCY). Based on expected dividend payments in 2018, yields from the two average about 4%. And I expect that both of them will be raising their dividends at a double-digit rate over the next several years.

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