It’s the unseen force shaking Wall Street: a post-close-era inflation resurgence that could change everything in the world of cross-asset investing.
As America’s flirtation with the fast-paced economy sends market-derived price With the highest expectations in more than a decade, Bloomberg solicited the views of top money managers on their hedging strategies for future success or failure.
One conclusion: the economics of trading stocks and real estate at interest rates would be turned upside down if runaway price projections are to be believed.
However, there are clear divisions. Goldman Sachs Group Inc. says that commodities have proven their worth for more than a century, while JPMorgan Asset Management is skeptical and prefers to hide in alternative assets like infrastructure.
Meanwhile, Pimco warns that the market’s obsession with inflation is misplaced and that central banks could still be below targets for the next 18 months.
The comments below have been edited for clarity.
Alberto Gallo, partner and portfolio manager of Algebris
- Likes hedges that include convertible bonds and commodities
We do not know at this point if the rebound in inflation will continue, but it is a good start. What we do know is that the markets are completely incorrectly positioned. Investors have been long QE assets like Treasuries, investment grade debt, gold stocks and technology. They’ve been long on Wall Street and short Main Street for a decade.
There will be a shift to real economy assets like small cap stocks, financials and energy stocks rather than rates and credit, and that will create a lot of volatility. We like convertible debt in value sectors that are linked to an acceleration of the cycle. We also like raw materials.
We are moving from an environment in which central banks pressed the accelerator by keeping interest rates low while governments pulled the handbrake with austerity, to one in which governments and central banks are now working together.
Thushka Maharaj, worldwide multi-Asset Strategist at JPMorgan Asset Management
- You prefer real assets over commodities and price-protected bonds.
Commodities tend to be volatile and do not necessarily offer good protection against inflation. Regarding indexed bonds, our study showed that their long duration exceeds the compensation for pure inflation offered by this asset. It is not the top asset on our inflation hedge list.
If inflation rose and continued to rise, and we believe it to be a low probability event, equity sectors that are geared towards recovery offer a good investment profile. We also like real assets and the dollar.
We expect volatility in inflation, especially at a general level in the coming months, mainly during the second quarter, driven by base effects, excess demand in the short term and disruptions in supply chains caused by a long period of lockdown. We see this as transitory and expect central banks to look at volatility in the short term.
Christian Mueller-Glissmann, Managing Director, Portfolio Strategy and Asset Allocation, Goldman Sachs Group Inc.
- Issues warning on indexed bonds and gold
We found that during a high inflation environment, commodities, especially oil, are the best hedge. They have the best track record in the last 100 years to protect you from unexpected inflation, one that is driven by shortages of goods and services, and even wage inflation like that in the late 1960s. Stocks have a mixed track record. We like value stocks because they are short lived.
The biggest surprise is the gold. People often see gold as the most obvious inflation hedge. But it all depends on the Fed’s reaction function to inflation. If the central bank doesn’t lock in fund returns, then gold is probably not a good choice, as real returns could rise. We consider indexed bonds to be in the same field as gold.
A sustained inflation scenario above 3% and rising is not our baseline scenario, but that risk has definitely increased compared to the previous cycle.
Nicola Mai, Sovereign Credit Analyst at Pimco
- Says inflation may not meet central bank targets in the next 18 months
If we look at the short-term volatility introduced by energy prices and other volatile price components, we see that inflation will remain low in the short term, with the central bank’s inflation targeting elusive for the next 18 months or so. The world economy has available capacity to adapt to growing demand. However, if spending were to increase steadily for years, this would likely end in higher inflationary pressures.
In general, we like curve strategies and believe that US TIPS offer reasonable insurance against excess inflation. Commodities and assets linked to the real estate sector should also benefit in an environment of rising inflation.
Mark Dowding, Chief Investment Officer, BlueBay Asset Management
- Match duration risk and warn of market complacency
Real assets, such as property and raw materials, will hold the best value in inflationary situations. Duration exposure to bonds is not attractive as yields should rise higher over several years if inflation normalizes to a level higher than what we are used to. The most overlooked risk is that there is too much complacency because everyone’s inflation expectations are based on what they have witnessed in the last five to ten years.
If there is a renewed economic recession, policy makers will find themselves in a difficult position. Therefore, there is a desire to ensure that you do not miss targets on the downside. Like a golfer hitting a ball over terrifying danger, there is a temptation to go big! Ultimately, this means that inflation results should be higher, not lower.
– With the help of Tom Hall