Editor's note: We continue our special holiday series today with a look at what became arguably the biggest investing story of 2021 – inflation.

Unlike the world's central banks, many economists, and other so-called "experts"... we saw it coming.

Specifically, way back in January, our colleague Dr. David Eifrig warned of persistent inflation ahead... And in his Income Intelligence newsletter, he detailed how this "mysterious" market factor works.

We shared parts of the January 2021 issue of Income Intelligence in the February 23 Digest – which we're republishing today – because we felt it was important information everyone should know. In fact, as I (Corey McLaughlin) wrote in February...

We want to make sure inflation doesn't catch you off guard.

Doc's research was must-read material in January. And it remains so now, nearly a full year later...

The government's "official" inflation readings end 2021 hitting multidecade highs on a year-over-year basis. And that's after the projections for the year were much, much lower.

As you know by now, this rising inflation left everyday folks on the hook for higher prices all year long. And with many investors wondering what to do to protect themselves and their portfolios against inflation as well... Doc detailed a solution.

Again, we originally published today's Holiday Series essay back in February. While some of the numbers and context might be outdated, the overall point remains as critical as ever...

The 'Mysterious' Market Factor That Defined 2021

By Corey McLaughlin, editor, Stansberry Digest

Are you 'cool' or 'uncool' with another stimulus package?

We're not making this question up...

It's essentially what Louisiana Sen. John Kennedy, a Republican, asked Federal Reserve Chairman Jerome Powell earlier today during Powell's semiannual testimony before the Senate Banking Committee.

Powell, not in the business of opining on the fiscal policy that Congress devises (at least, not directly), declined to answer... which is kind of an answer in itself.

As we see it, and as we'll detail in this essay, more fiscal stimulus (like more stimulus checks) might make Powell's job leading the U.S. central bank harder in the years ahead and ultimately threaten the economy and markets.

Let me be clear...

We're not saying people on Main Street couldn't use some more money in their pockets today. That's especially true for folks who've lost their jobs because of the COVID-19 pandemic and ensuing shutdowns... and need help to pay their bills until things get better.

But we also must address the long-term consequences of continued, unprecedented stimulus... with likely more on the way by next month. The next round of stimulus will only increase the debt in our already-overburdened financial system.

And as a result, we see a threat that impacts anyone with money in the markets today...

We're talking about inflation...

Indeed, although Powell said again today that the Fed's broad measures of inflation remain below their target (now 2% and above), we are seeing "real world" inflation...

In the February issue of Income Intelligence, our colleague Dr. David "Doc" Eifrig discussed this topic, which directly impacts income investors looking for safe yield in an already-low-rate world. As Doc wrote...

We're on record as watching for higher inflation. Oil, silver, copper, and corn all shot up this month, pushing commodities up around 50% on the year.

We're also seeing upticks in our Real-World Inflation indicators – including bread, which is up 14.4% on the year.

Elsewhere, Doc notes that milk prices are up 6.6% over the past 12 months, ground beef is up 5.1%, and the price of a standard bicycle has gone up 39.3% since a year ago.

Inflation, as a word, has a negative connotation – similar to 'taxes'...

It sounds like one of those things that nobody likes. But the right amount of inflation is actually good...

No inflation at all means economic growth isn't happening.

In February and March 2020, for example, "deflationary" forces struck the world economy by way of a pandemic. Supply and demand in various sectors took massive hits... The rally back from those lows has been described as "reflationary."

But too much inflation, or "hyperinflation" – prices rising and people not having more money, or money that isn't as valuable, to keep up – can be an economy-killer...

Nobody wants that, we don't think...

After all, if you're putting your money to work and looking for decent returns, you want it to work better for you than the federal government is at debasing dollars at its leisure... And as we've seen, government officials are really good at that.

In the 12 months through mid-February, the U.S. government created many trillions of dollars that simply didn't exist previously – 25% more, in fact, as measured by the "M2" money supply.

As you might remember... M2 includes cash, checking and savings deposits, and money-market accounts and mutual funds. It's money available to the economy.

And the Fed quietly – when it comes to the headlines at least – continues to add $120 billion to its balance sheet each month to help fund government spending that reached a stunning $32 trillion at the end of 2020.

We don't believe this approach to money strikes anyone as "sound." And on a practical level, the concern goes like this...

For every new dollar created, the value of each brand-new and existing dollar goes down...

You can buy less for the same amount... and even less when prices go up. But monetary policy – like bond-buying and record-low interest rates that the Fed sets – doesn't create inflation on its own...

In January, Doc dedicated an entire issue of Income Intelligence to the topic of inflation. And he explained in part...

If you wanted to point to three sources of inflation, you'd look to accommodative monetary policy, expansionary fiscal policy, and a strong economy. There's no question that we have the first two ingredients – and we think the third is about to kick in as well.

In the February 22 Digest, we mentioned the potential for an economic rebound in the year ahead as folks get COVID-19 vaccines in their arms... though that assumes enough people actually get them.

That's good for people who want to leave their homes and go back to restaurants or their physical workplaces one day without needing to wear a mask. But it also means a recipe for inflation. As Doc wrote in the January issue of Income Intelligence...

A set of measures known as "breakevens" evaluates how much inflation the market expects. In the depths of the crisis, markets saw five-year inflation at just 0.16%. But rather quickly, expectations have risen to crack 2%.

These breakevens tell us that right now, the market expects average inflation of 2.1% per year over the next 10 years and 2.09% over the next five.

As Doc has said many times over the years, his end conclusion is "inflation remains mysterious, poorly understood, and difficult to predict." But he also noted a few hallmarks...

We've covered in prior issues how an expanding money supply doesn't automatically mean inflation. Money growth in excess of money demand does. Yes, the money supply has grown dramatically... But since the financial crisis, banks have held extra reserves, and corporations have beefed up their balance sheets. The money hadn't made it out "into the system" so to speak.

So monetary policy alone didn't create inflation. But now the government has stepped in.

Now, based on his research, Doc says another stimulus package under President Joe Biden's administration "will push us past the sweet spot and over into the risk of inflation" that may run as high as 4%. More from the January issue of Income Intelligence...

Again, that's not to say it's right or wrong for a broader policy perspective. On the full spectrum of values, you may conclude that risking inflation to help those in need is the right thing to do.

But we do think that this stimulus will cause inflation to pick up in 2021 and beyond.

The point is...

When it comes to your portfolio, the inflation story matters maybe even more than you think...

As Doc detailed in Income Intelligence back in January...

The expectations for inflation will drive investment returns. When you expect inflation, you position yourself differently than you would if you expect deflation. And other investors doing the same thing will drive some investments to lead and others to lag.

And in early 2021, Wall Street investors started betting on higher inflation in the months ahead...

One way to gauge inflation expectations is to look at U.S. Treasury yields. We wrote in the January 12 Digest that the 10-year Treasury yield moved to more than 1% for the first time since March 2020. That got our attention...

For one, yields rise when bond prices fall. That means investors are selling bonds and moving into other assets, like stocks, to deliver a better return in the face of higher inflation expectations.

Said another way, investors on balance were starting to demand more yield for putting money to work in low-risk U.S. government bonds.

More narrowly, higher longer-term yields are also good for banks, which make money by borrowing at short-term rates – which have been largely dictated by Fed bond-buying practices (driving yields down) – and lending at long-term rates, which are more market-driven.

If things were going well for the hated, beaten-down banking sector, it told us the U.S. economy was improving. With this in mind, we wrote in the January 12 Digest...

We'll have to keep tracking this trend for longer than a week, but there's no doubt that the longer-term, market-controlled 10-year Treasury rate has been rising lately. Meanwhile, the two-year U.S. Treasury yield, which typically moves in sync with interest-rate expectations, is a miniscule 0.14% and has barely budged since May.

Since then, longer-term yields have kept rising... The 10-year Treasury yield closed on February 22 at 1.4%. That's still historically low, but it's more than 25% higher than it was January 12 (up from 1.15%). Meanwhile, the two-year Treasury yield has actually decreased a little to 0.11%.

[Editor's note: These numbers were as of February 23... Remember, that's when this essay was originally published. Today, the 10-year Treasury yield is around 1.5%, while the two-year Treasury yield is about 0.7%.]

All in all, this means the "spread" – the difference between long- and short-term rates – has widened to its largest gap since January 2017.

Usually, higher inflation and longer-term yields lead the Fed to raise its benchmark interest rates to slow inflation. But that won't happen any time soon...

We saw a lot of nervous market observers ahead of Powell's testimony today [February 23], concerned that the central bank would allude to a rate hike sooner rather than later... or possibly tighten its "easy money" policies in other ways.

Instead, Powell said inflation was "soft" overall and the recovery has a long way to go. He said he thinks inflation will be volatile but doesn't expect pandemic-opening price hikes "will be large and persistent."

We'll see.

So with that said, how do you protect your portfolio from higher levels of inflation?

In any case, it's wise to prepare for higher inflation this year and beyond...

We go back to Doc for some advice everyone can heed, especially those who are heavy into income investments. As Doc wrote in the January issue of Income Intelligence...

For one, own stocks over bonds.

Fixed-income instruments pay just that: fixed incomes. And when inflation reduces the value of each dollar, those income streams are worth less.

Additionally, even with stocks at high valuations, they still look cheap relative to bonds. Yields are remarkably low – and with inflation coming, many bonds likely have negative real yields.

But don't just go buy any stocks...

It's amazing how "high-quality, capital-efficient businesses" – the kind we love here at Stansberry Research – are often the answers to so many investing dilemmas.

Inflation threats are another reason why investors should own good businesses. These companies can react to higher prices by charging more and still see consistent demand, and continue to grow... As always, though, you want to heed your stop losses, too.

Another piece of general advice under inflation, according to Doc, is to own "hard assets." These are things like real estate, gold, and inflation-protected securities.

To this list, we will add assets like art and collectibles, or even bitcoin... which several of our other editors have suggested in these pages lately.

In the end, we want to make sure inflation doesn't catch you off guard. It's a factor that savvy investors, like Doc, always take into consideration and are keeping a close eye on today.

Right now, in late February, the Fed is saying it will let inflation run higher until employment numbers rebound fully... and more stimulus from Congress and a reopening economy on the heels of a COVID-19 vaccine rollout may be on the way to fuel it.

So this is a long way of saying, we'll keep watch on this critical trend in the months ahead.

Editor's note: Doc believed inflation would become such a significant threat to most individual investors that a few months later, he went live with more details – and offered a solution on how to protect your money – in what he called his "retirement wake-up call."

Doc and his research team noted that in an inflationary period like today, simply splitting your portfolio between 60% stocks and 40% bonds – the conventional wisdom – isn't the right move if you want to keep pace with inflation.

Bonds aren't likely to do much for you (except lose money)... And even a lot of stocks might not return as much as you'd expect in the years – or perhaps even decade – ahead.

With conventional wisdom, you're taking on risk that most investors don't even realize exists.

Doc said folks essentially need to be pickier about what they do with their money today. Related to that, he and his research team came up with a solution...

They devised a fully allocated portfolio that has proven to outperform the broader market. It's something that any individual investor can use... And it can take as little time as one update per year.

This strategy, in our opinion, is critical information that every investor should know in order to "inflation proof" their portfolio and protect – and grow – their wealth. And it's not too late to make sure you're not caught off guard... Check out Doc's complete message right here.