Prior to the pandemic, talking about the return of inflation would have got you laughed out of the room. If anything, persistently low inflation was arguably something of an issue. Those times are over. The consensus now is that inflation is right around the corner.

The scene is certainly set. A tsunami of pent-up demand is waiting to wash over economies when they fully open up from lockdowns. At the same time, the bazookas of fiscal and monetary stimulus are poised to keep getting fired irrespective of what will hopefully be the quick resumption of normal service.

Positioning Your Portfolio for Inflation
Prior to the pandemic, talking about the return of inflation would have got you laughed out of the room. If anything, persistently low inflation was arguably something of an issue. Those times are over. The consensus now is that inflation is right around the corner.

The US has declared itself happy to “run the economy hot”, but with President Biden’s $1.9 trillion relief package in view, many fear a pitch into overheating territory and inflation hitting 4% this year. Meanwhile, here in the UK our vaccination success means economic growth predictions keep getting revised up and up, and many now believe a frenzy of consumer spending could rapidly spike inflation past the 2% annual rate targeted by the Bank of England.

Inflation-proofing ideas

So, what can investors do to position their portfolios for an inflationary environment?

Firstly, investors might want to look at their bond exposure since inflation will erode the value of the coupons they pay out over time, along with the principal due back at the end of the term (and returns have already been poor). Bond markets are typically a bellwether of inflationary fears and we’re already seeing rising yields, signalling nervousness.

Inflation-linked bonds are the order of the day, according to many experts. They are also warning against long-term durations due to the risk of interest rates being ratcheted up to cool inflation and yields thus becoming less lucrative in comparison. It should be noted, however, that governments will be loath to raise interest rates given gargantuan public debt levels.

Secondly, investors might want to increase their commodities exposure. Real assets have historically been the beneficiaries of increased inflation because higher costs of production are typically reflected in price rises and, as we recently explored, several other factors are heralding the beginning of a commodities supercycle that could last a number of years. We’ve seen very strong showings from crude oil, cobalt, nickel, copper and iron recently and massive infrastructure investments are likely to provide further support that could make commodities important to defensive portfolio positioning.

Mixed messages on gold

One metal that is of course always on investors’ minds when inflation is in view is gold. However, while it is seen as a good hedge against inflation and typically benefits from a commodities upturn, it wouldn’t be so attractive if interest rate rises did kick in, due to the relative long-term stability of its price (and the costs of holding the precious metal). The prospect of rising risk appetite ushered in by a return to economic growth - and therefore a flight away from safety - mean that many predict prices will fall in the short to medium term.

Now to cash. As any savvy investor knows, your cash deposits have to at least keep pace with inflation so that its real value isn’t eaten away. The chances of you achieving that are very slim indeed, at least as things currently stand, since you’d be hard-pressed to find a savings account offering anything near the 2% inflation level now seen as a real possibility. Although interest rate rises could change that picture, you can be sure that institutions aren’t going to get into a bidding war for savers’ money very rapidly after so many years of rock-bottom rates.

Be selective with stocks

And finally, to equities. As we have seen, favouring equities over bonds seems a sensible course in light of fixed-income’s risk of seeing real value eroded. It is also the case that equities can benefit from rising prices and it is generally thought that valuations flourish from a certain amount of inflation (up to 4%).

That said, investors are going to need to be highly selective in the stocks they pick. There has been much talk of a mass rotation away from the winners of the pandemic (tech growth stocks) towards temporarily unloved sectors centred on real life pleasures (like travel and recreation). However, we have to bear in mind that nothing is assured yet when it comes to the end of COVID-19. As we recently explained, a long-term view and focus on fundamentals should drive any alterations to your portfolio, rather than simplistic messages like “sell tech, buy travel”.

In reality, you should always have an eye on inflation protection in any environment, particularly because investing, rather than speculation, is all about the longer term. A well-diversified portfolio will always serve you well and you shouldn’t have to deviate too far from a well-considered asset allocation strategy whatever the future brings. As the old saying goes, focus on time in the markets rather than timing the markets and you won’t go far wrong. 

Important information

This piece is for informational purposes only, and is not intended in any way as financial planning or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.

Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.

Gary Skovron
Gary Skovron

COO of ARQ