(AFR) Investors risk placing too great a focus on the current burst of inflation and should instead tweak portfolios to hold commodities and real estate alongside shares to ride out the lurch in consumer prices, according to Invesco’s top market strategist.
In the US, the drumbeat of evidence pointing to creeping consumer prices reached a fresh high last week when inflation jumped to 6.2 per cent in October on an annualized measure – the biggest leap in three decades.
In response, the country’s five-year break-even rate – a market-based measure of inflation expectations – shot to a decade high.
These types of headline-grabbing data points will continue for the next year, but investors should not be swayed into believing sharp inflation will persist beyond then, warned Kristina Hooper, chief global market strategist for Atlanta-based Invesco, one of the world’s largest fund managers with $1.8 trillion in assets.
“Inflation likely won’t be over in a few months, but I believe it is likely to peak in mid-2022 and then start to recede,” she said.
“Inflation is a necessary evil as countries emerge from the pandemic,” and especially for those “that provided adequate fiscal stimulus”, through the downturn.
Fears over brisk inflation have dominated corporate updates over the past few months and most of the questions Ms Hooper has fielded from investors over the past few weeks have focused on inflation. Even financial advisers say this is the main worry among their clients, she said.
However, investors risk focusing too tightly on rising prices and forgetting the underlying factors behind them, many of which will abate as the recovery matures.
Perfect storm
“Household savings are elevated, there is pent-up demand, there are labour shortages and there are supply chain disruptions. We’re facing a perfect storm,” she said.
“There are multiple reasons for elevated inflation, and some factors, such as pent-up demand, will dissipate sooner than others, but the general trend should improve in the back half of 2022.”
Walmart, the US retailing giant and the country’s biggest employer, said this week it was “fully staffed” after struggling to hire enough workers over the past year. The company also increased inventories by 11.5 per cent in the September quarter in a sign of easing strains on global supply chains.
Importantly, rising consumer prices have failed to dent corporate profits, insulating equity investors from the sting of inflation.
The third-quarter net profit margin for companies in the S&P 500 index of blue chips sits at a “robust” 12.9 per cent, with most companies having reported for the period, Ms Hooper said.
“A number of companies reported being able to pass increased costs on to customers, which helps explain the very healthy profit margins,” she said. “While this is not positive for consumers, it should be positive for equity investors.”
To see through the hiccup of rising prices over the next year, Ms Hooper suggests insulating portfolios by holding stocks that enjoy mixed blessings from inflation, and buying real estate and commodities.
“I favor maintaining exposure to equities, including dividend-paying equities, inflation-protected securities, and other asset classes that have historically performed well during inflationary periods, including real estate and commodities,” she said.
Risks remain
However, the biggest lingering risk to markets from the inflation spike rests with the US Federal Reserve and its outsized influence on the global economy.
Should the Fed raise rates or cut off its bond buying too quickly, or allow ultra-easy policy to run too long, the financial markets risk tumult, according to Ms Hooper.
These risks are somewhat elevated as Fed chairman Jerome Powell, who has remained a steady hand during the pandemic, may be removed in the coming days.
Lael Brainard, a potential replacement, is regarded as even more dovish, reducing the likelihood of a sudden tightening in monetary policy, Ms Hooper says.
The US central bank is aware that raising interest rates may have little impact on short-term inflation, as it “will not force more people back into the workforce or get ships unloaded in the port of Long Beach any faster,” she said.
“The Federal Reserve will not overreact to the inflation data,” she said. “I am confident that inflation will peak by mid-2022 and that the Fed will not make a policy error – and that’s the real fear for investors with regard to inflation.”
