How should investors respond then? One of the most downloaded papers over the past 12 months on the SSRN academic research site is titled “The Best Strategies for Inflationary Times.” The study, by researchers from hedge fund firm Man Group Plc and Duke University, makes for uncomfortable reading. Drawing on almost a century of data for the US, UK and Japan, it concludes that equities and bonds both perform poorly during inflationary times. The annualized real return on US stocks averaged -7% during eight such periods since World War II. Real estate doesn’t offer much of a refuge: It also provides negative real returns, though not of significant magnitude. The one major asset class that reliably outperforms when inflation is high and rising is commodities, with a real return averaging an annualized 14%.
The search for havens from the worst inflation in four decades feels like it’s about to get a lot more real. The bad news is that the task isn’t looking at all easy or straightforward, at least for individual investors whose choices are confined to the standard asset classes and who rely on a traditional 60-40 portfolio mix of equities and bonds to weather the ups and downs of market cycles. If US policymakers follow through on their aggressive tightening rhetoric, we could be in for some testing times.
The upsurge in US consumer prices has long passed the point at which it could be considered temporary, yet the stock market has remained remarkably resilient. The benchmark S&P 500 was less than 6% off January’s record high as of Friday’s close. The trouble for investors betting that markets will ride out this bout of inflation without serious damage is that their confidence is part of the problem. Monetary policy works through financial conditions, and falling stock and bond prices tighten them, as 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 have to raise interest rates to achieve the desired result.
