Inflationary pressures are building as the economic recovery gains traction—and the markets are responding. On one hand, this is a normal part of a healthy economic cycle: production declines during downturns, only to face periods of scarcity as demand begins to rebuild. On the other hand, the COVID-19 cycle has been unprecedented in many ways, raising an important question for investors: Could inflationary pressures be here to stay?

After more than a decade of persistently weak inflation, stronger inflationary pressures could have a variety of important implications. Higher inflation could influence monetary policy globally. Less monetary accommodation would contribute to higher interest rates, impacting borrowing costs as well as the tradeoff between stocks and bonds. In the long term, inflation also acts as a tax on wealth and investment returns. Investor sentiment and positioning could shift.

Given these inflationary concerns and the investment implications, we asked our seasoned experts from several of our boutique investment firms to provide some perspective by sharing their insights on the market.

 

MacKay Shields: CPI surges in April, but limited inflation implications for the long term

For some time now, we have been expecting a move higher in inflation readings as post-vaccine consumer demand exceeds recovery in productive capacity. While ahead of expectations, April’s Consumer Price Index (CPI) print remains consistent with this view, with much of the price pressure occurring in a handful of categories experiencing these supply-demand imbalances, including labor shortages.

The April CPI print does not change our view that while we are likely to experience inflation that is higher than the prior expansion, it will still average only moderately above the Federal Reserve’s two percent objective. As previously noted, an important driver is the impact of current supply constraints, which should resolve over the next six to twelve months—leading to some cooling of inflation pressures. Further, the longer-term determinants of inflation, including the policy setting, suggest only moderate price pressures thereafter.

 

CBRE Clarion Securities: Infrastructure and inflation

Inflation has been contained over the last 25 years in the U.S., but the recent spike in the CPI is challenging investors’ view that inflation will remain tame in the medium term. There is a case to be made around base effects, but due to several factors, principally easy monetary policy across the world, future inflation is a more relevant risk today than it has been for a long time. While sustained inflationary pressures are not our base case, today’s extraordinary macroeconomic environment suggests investors should consider some inflation protection in their portfolios.

 

CANDRIAM: Strong economic recovery and loose monetary/fiscal policies bring inflation back into the spotlight

In the short run, there are many reasons for tensions to persist: higher commodity prices, surging shipping costs, bottlenecks in some industries (semiconductors in particular), depleted inventories, but also price increases in the service sector due to the reopening of economies. All these factors have combined to push prices higher: producer prices, as well as consumer prices, have significantly accelerated in many countries in April. Moreover, the Purchasing Managers’ Index (PMI) surveys are generally pointing to higher input prices and lengthening supplier delivery times—signaling that inflationary pressures are likely to persist for some time. However, this phase could reasonably be regarded as temporary (i.e., lasting a couple more months) as supply adjusts to the reopening and inventories are rebuilt.

 

Epoch Investment Partners: America’s risky economic experiment – Will the inflation genie escape from the bottle?

While the aspirations of Bidenomics are laudable, the ambitious policy framework features historic levels of fiscal stimulus and a novel approach to monetary policy that is alarmingly tolerant of inflation. These plans have been described by Larry Summers of Harvard as “the least responsible economic policy in 40 years.” The iconoclastic professor has also emphasized, “If inflation expectations are allowed to ratchet up—which certainly appears to be a possibility—the costs, both economically and politically, could be very high.”

 

NYL Investors: Crossroads for inflation?

As vaccinations and economic re-openings accelerate, 2021 will likely be viewed as the crossroads of the global pandemic and the start of a return to “normalcy.” But when we think about the implications the pandemic has had on the economy and the impact of historic monetary and fiscal policy, will 2021 also be viewed as the crossroads for inflation? Undoubtedly, this is the most important question for financial markets this year, and the answer will have far-reaching consequences for investors.

 

Multi-Asset Solutions Team: Asset allocation approach to managing inflation risk

To weigh the impacts of inflation on portfolios, investors must consider: Is inflation here to stay?  In the next 12 months, we expect base effects and transitory factors, such as supply chain constraints and higher energy costs, to drive inflation volatility. Volatility in rates and equities is likely to follow. That said, there is a difference between today’s shortages and an overheating economy. It takes time to refill job openings and to get idle workers to where new jobs are being created; but unless we expect a shortage of production capacity in the economy, supply-demand imbalances will correct in the next few quarters. Monetary policy need not over-correct in the meantime.

 

Options for a near-term inflationary environment include:

  • Rotate into asset classes that benefit from rising inflation and rates. Cyclical and value equities in sectors such as materials, energy, and financials have historically outperformed as economic growth and inflation were rising. In fixed income, short duration high-yield bonds and floating rate loans have tended to benefit from rising rates or a steepening curve.
  • Leverage future sources of expansion. The fiscal impulse towards infrastructure and green energy may support those asset classes. Commodities may stand to benefit from this trend as well as the general cyclical improvement.
  • Look for companies with pricing power. Even if inflationary pressures are temporary, sudden price changes and the associated supply chain disruptions can be challenging. With earnings expectations for the rest of the year already sky-high, investors must be careful in discerning which businesses can maintain earnings momentum through these frictions.
  • Consider multi-asset income. Diversification is still important for investors, but the yield from traditional fixed-income assets may remain lower than long-term historical averages. This is where investors have begun to look for other ways to consider the 40% fixed-income allocation: a multi-asset approach to income. A rebounding economy has historically been aligned with some outperformance for value sectors, dividend payers, the high-quality segments of high yield, and international developed equities. Investors can consider these areas for building the income part of their portfolio. The combination of long-term trends, cyclical macro tailwinds, and careful security selection—could create the foundation for a strong “new economy” core allocation.

The views expressed herein are from MacKay Shields, CANDRIAM, NYL Investors, CBRE Clarion Securities, Epoch Investment Partners, and the Multi-Asset Solutions Team, and do not necessarily reflect the views of New York Life Investment Management LLC or its affiliates. New York Life Investments engages the services of affiliated, federally registered investment advisors such as MacKay Shields LLC and CANDRIAM, and unaffiliated, federally registered investment advisors, such as CBRE Clarion Securities and Epoch Investment Partners, Inc. The products and services of New York Life Investments’ boutiques are not available to all clients and in all jurisdictions or regions. 

This material represents an assessment of the market environment as of a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any particular issuer/security. The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial professional before making an investment decision.

“New York Life Investments” is both a service mark, and the common trade name, of certain investment advisors affiliated with New York Life Insurance Company.

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