Inflation leaving you deflated?
In recent times we have observed a combination of supply-side shocks and a policy response that have reinforced each other to drive inflation to significantly elevated levels. The COVID-19 global pandemic wreaked havoc on supply chains and this was further compounded by the war in Ukraine. The much-needed policy response to the pandemic (loose monetary and fiscal policy to alleviate the strain on companies and households disrupted by lockdowns), in hindsight, looks like it remained in place for too long, driving consumer demand to levels producers have struggled to keep up with.
There are a range of factors that can influence inflation:
Double-digit inflation readings in the US in the 1970s and 1980s presented a difficult period for households, companies and the investment community. ‘The Great Inflation’, that started in the mid-1960s lasted for 17 years and was considered a failure of American macroeconomic policy . We are learning that elevated inflation cannot be resigned to the history books. In 2022, we are observing inflation rates that are very close to double-digit once again.
So, what can investors do to hedge inflation risk?
There are a number of asset classes and strategies that have, historically, performed well during inflationary periods. Commodities, gold and quality strategies are typically considered inflation hedges for this reason.
Historically, commodities have tended to move in tandem with inflation. While many other cyclical assets, like equities, react to ‘expected inflation’ (inflation expectations formed by strength of economy and monetary growth), commodities also tend to respond well to ‘unexpected inflation’ (inflation driven by unanticipated supply or demand shocks). As the demand for goods and services increases, the price of those goods and services rises, which inflates the prices of the commodities used to produce them. Find out more about our Commodities range.
Gold often acts more like a currency than a commodity but, unlike most fiat currencies, its supply cannot be increased. As such, it has a ‘super-haven’ status and is often considered an excellent store of value due to its desirability and moderate scarcity. When the purchasing power of cash is being eroded, investors often seek out hard assets, considered to have intrinsic value due to their finite supply. Find out more about our Gold range.
Quality strategies are often touted as ‘all-weather’ investments. They can help build wealth over the long term in periods of low volatility, whilst also being a defensive asset during economic downturns. Quality stocks are identified by their solid business models, strong brand positioning and financial strength. These attributes can help withstand inflation as their high pricing power often allows them to defend their profitability in a high-inflation environment. Find out more about our Quality strategy.
Sensitivity of asset classes to inflation
Broad commodities tend to rise with both expected and unexpected inflation. Gold tends to rise with unexpected inflation. Very few assets rise with unexpected inflation. US Treasury Protected Securities (TIPS) - an instrument designed for inflation protected - is inferior to broad commodities in this regard.
Sensitivity of major asset classes to expected and unexpected inflation
The importance of the ‘growth’ factor
Commodities and gold appear to do well in high inflation/strong economic growth scenarios. But even when economic growth falls (high inflation/low growth), commodities and gold have historically performed well relative to equities.