The rise in US consumer prices is well past the point at which it could be considered temporary, but the stock market has remained remarkably resilient. The benchmark S&P 500 was less than 6% down from January’s record high at the close on Friday. The problem for investors who are betting that markets will survive this inflationary spurt without serious damage is that their confidence is part of the problem. Monetary policy affects financial conditions, and falling stock and bond prices are exacerbating them, Bill Dudley, former President of the Federal Reserve Bank of New York, wrote for Bloomberg Opinion last week. The longer markets remain buoyant, the higher the Fed may need to raise interest rates to get the desired outcome.
How should investors react then? One of the most downloaded articles over the past 12 months on SSRN’s academic research site is titled “The Best Strategies for Inflationary Times”. The study, by researchers at hedge fund firm Man Group Plc and Duke University, is uncomfortable to read. Using almost a century of data for the US, UK and Japan, he concludes that both stocks and bonds perform poorly in times of inflation. The annualized real return on US stocks has averaged -7% in eight such periods since World War II. Real estate doesn’t offer much sanctuary: it also offers negative real returns, albeit not to a significant extent. The only major asset class that reliably outperforms when inflation is high and rising is commodities, with an average annual real return of 14%.
This was a favorable and very useful observation – in March 2021 when the paper was first published. The problem is that commodities have been running at full steam for months, so those just waking up to the heaviness of last week’s Fed talk may already have missed the boat. The Bloomberg Commodity Index is up 48% over the past year and has more than doubled since its March 2020 low. The commodities rally could arguably go much further as the index is still at just over half of its pre-financial crisis high. However, the gain in the benchmark masks large fluctuations; The commodities most likely to be bought by retail investors, such as gold and silver, are among the laggards.
In reality, retail investors aren’t likely to surf the Russian-induced surge in natural gas prices or wade into the London Metal Exchange to battle beleaguered Chinese tycoons — and that’s a good thing, given the stomach-churning volatility commodity futures can gauge. The more obvious route for private buyers is into resource company stocks, although the returns here are less promising. According to the Man/Duke study, no single stock sector offers significant protection against high and rising inflation, and even energy stocks only generate marginally positive real returns. (Exchange traded funds offer more targeted exposure.)
What about non-US equity markets, where valuations are less stretched and policymakers may be less anxious to cut prices? The return of inflation follows a long period of post-crisis outperformance by US equities. On price-to-earnings multiples, the MSCI World Exclusive United States Index is the cheapest relative to the S&P 500 since the global financial crisis. The MSCI Emerging Markets Index is about to do so. If this is a regime change for the markets, as many believe, it may be time for the trend to reverse.
It’s probably not that simple. For one thing, inflation is a global phenomenon, leaving few, if any, markets untouched. In addition, the speed and extent of a US withdrawal will affect the outlook. Emerging markets in particular have tended to do well when US stocks have been flat and investors have been looking elsewhere for higher yields. However, when American markets plummet, beware. Any significant downside break would certainly resonate. That doesn’t even take into account the destabilizing effects of sanctions on Russia and a worsening Covid outbreak hurting an already flagging Chinese economy.
That leaves more esoteric choices. Bitcoin has its proponents, but has too short a history and too high volatility to be considered a surefire hedge against inflation. There are also collectibles such as art, wine and stamps. The Man/Duke study found that these have performed well during inflationary periods in the US, with real annual returns of between 5% and 9%.
Maybe that’s worth considering. If it doesn’t work out, at least you’ll have something nice to look at while inflation eats away at the value of your portfolio.
More from the Bloomberg Opinion:
• Consumer stocks are starting to think the Fed means business: Jonathan Levin
• An inflation update and how Brainard gets it right: John Authers
• Retire early to lay flat? Watch Inflation: Matthew Brooker
This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.
Matthew Brooker is a columnist and contributing editor at Bloomberg Opinion. He was previously a columnist, editor and bureau chief for Bloomberg News. Before joining Bloomberg, he worked for the South China Morning Post. He is a CFA charterholder.
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