In-depth Analysis

Trading inflation

The acceleration in the rise of consumer prices of the last 8 months continues to spread. November data indicated that in the US, inflation reached 6.8% on a yearly basis, the highest reading since the early 90s, with a similar dynamic occurring around the globe. In some cases, the numbers start to look scary, like in Turkey, where annual inflation climbed to more than 20%, triggering a loss for the currency that exceeds 40% over the last 3 months. Unusually, the Turkish central bank is reacting by lowering interest rates, a move widely seen as a dangerous economics experiment that may open the way for runaway inflation.

Thankfully, most central banks, including the US Federal Reserve, the European Central Bank and the Bank of England, aren’t willing to gamble the economic stability of their countries and have already started, or look set to initiate, the tightening of monetary policies, by tapering quantitative easing and hiking interest rates. Despite this tilting towards hawkishness, many analysts, and some economists believe the trend still has some way to go, forecasting the continuation of consumer’ price rises throughout 2022.

Over recent decades inflation remained, apart from a few feeble spikes, subdued across the developed economies of the west. Such environment, which to a large extent resulted from the combined deployment of stringent fiscal austerity measures and generous monetary stimulus, provided goldilocks-like conditions for risk related assets to flourish. Tech stocks and cryptos, were among the main beneficiaries, with Amazon, Apple and Tesla all reaching a market capitalization above one trillion dollars. However, the pandemic and unsettling populistic political movements changed everything. Over the last 20 months austerity gave way to fiscal stimulus, which, combined with supply chain issues, brought back inflation.

Investors will operate differently in an environment of high inflation, which, as mentioned, is expected to remain elevated throughout 2022. They will readjust their portfolios, buying assets that offer more returns or hedge against high inflation. This year already, Treasury Inflation-Protected Securities have been in high demand (these are US government issued bonds indexed to inflation). Commodities, like oil, gold, and softs such as wheat and soybeans, also tend to do well, as their value will rise alongside consumer prices.

Another sector likely to grow 2022 is property. Real estate investment trusts are becoming increasingly popular because they generate income from rents, which, as we know, go up during times of high inflation.

So, government bonds, commodities and property are likely to do well in the year ahead. But, as winners emerge, there will also be losers as investments are diverted to new asset classes. Among the losers we will probably find growth stocks, those whose current price is determined by future valuation and not actual results – the tech sector, the stand-out performer of the last 2 years, will be particularly exposed to this dynamic. There are already signs confirming this trend, with the performance of the Nasdaq index before the Christmas break looking ominous, with a drop of 3.5% in the week up to December 17.

 

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