Markets tremble at risk of stagflation: these are the assets to beat the monster

Markets are beginning to doubt the transience of inflation. The US CPI data has surprised to the upside this week, generating a sell-off in bonds and driving stocks back. Investors are beginning to ask questions and move some of their capital toward assets that have performed best during periods of higher inflation. Although there is still no certainty about the future evolution of prices, what can already be said is that inflation is lasting longer than expected and is reaching levels that were in the forecasts of very few institutions.

The CPI in the US stood at 6.2% in October, maximums not seen since December 1990. This data caused a slight earthquake in the markets that nevertheless shows where ‘the shots can go’ if things go wrong. gets ugly with inflation. Bonds fell significantly (interest rose), stocks also fell on Wall Street, while gold was the big winner of the day.

Sean Markowicz, head of strategy, studies and analysis at Schroders, has produced a kind of manual or note in which he describes the behavior of each type of asset according to the inflation cycle. This expert explains that, in general, there are four different phases of the economic cycle based on the evolution of production and inflation: goldilocks or goldilocks (when the economy is neither too hot nor too cold, so it supports notable growth with low inflation), disinflation, reflation and stagflation. In each cycle you have to be invested in some assets or others to take advantage of market movements.

This economist believes that evaluating the behavior of asset classes during each phase using GDP can be quite complex, since production is an indicator that is published late.

“As a result, we substituted growth for the US Conference Board’s Leading Economic Index (LEI), which is designed to pinpoint tipping points in economic data more effectively than GDP.” This index, together with inflation, suggests that the cycle is in a transition phase from reflation to stagflation (high inflation and moderate or stagnant growth), a monster that savers fear.

Schroders’ analytics department has calculated what the actual return (discounting inflation) has been in each part of the cycle over the past few decades. For example, during periods of stagflation, gold (+ 22.1%), raw materials (+ 15%) and real estate investment funds (REITs) (+ 6.5%) have performed the best. On the other hand, equities have tended to suffer (-1.5%).

“This makes sense, as gold is often considered an active haven, so it tends to appreciate in times of economic uncertainty. Real interest rates also tend to decline in periods of stagflation, as inflation expectations rise and growth expectations decline. Lower real rates reduce the opportunity cost of owning a zero-yield asset like gold, making it more attractive to investors, “says Markowicz.

The commodities (for example, raw materials and energy) are a source of costs for companies, as well as a key component of inflation rates. Therefore, they tend to perform well when inflation is also increasing (often because they are the cause of rising inflation). However, returns are weaker during periods of stagflation compared to periods of reflation, when they benefit from the additional tailwind of increased demand and good times in the overall economy.

Invest in housing

Similarly, real estate investment funds offer partial hedge against inflation through the transmission of price increases in rental contracts and property prices.

Although reflation has tended to be positive for equities (+ 14.6%), stagflation has been more problematic (-1.5%), as companies grapple with falling revenues and rising income. the costs.

“Treasuries are anyone’s guess. In theory, they should benefit from the fall in real rates, driven by declining growth. However, rising inflation eats away at their income, pushing yields up and prices down, “says the Schroeders economist.

In practice, the extent to which this hurts the yield of the bonds will depend on their duration and their initial yield (higher yields provide a greater cushion to absorb rate hikes). Historical data reflects this complex interplay of factors: Treasuries have delivered a low but positive annual real return (+0.6).

So if the investor is anticipating a stagflation scenario, gold may be a good option to obtain some returns. Perhaps the most dangerous option in these times is liquidity (deposits, monetary funds, cash …), given the high level of financial repression: official interest rates are close to 0%, while inflation is at highs of the last decades. Having the money in liquidity is losing purchasing power day by day.