For the first time in decades, investors need to focus on the impact of higher inflation. Portfolio Manager, Russ Koesterich, CFA, JD discusses how.
A generation of investors have never had to seriously worry about inflation. For more than two decades asset allocation and risk mitigation exercises have been more about protecting against too little growth, much less so about too much inflation.
Today, potential market headwinds are of a different sort. Rising prices of goods and services and their impact on both interest rates and profit margins have become the larger concern. The good news is that rising inflation does not necessarily mean the end of the bull market. However, the shift in the macro backdrop does necessitate a shift in security selection. Investors now need to ensure enough exposure to those stocks likely to benefit from accelerating inflation.
The abrupt and broad spike in prices has taken inflation to multi-decade highs, with core inflation in the U.S. rising at the fastest pace in 30 years and headline inflation near a forty-year high.
Not only is inflation higher, but it is also more volatile. During the “Great Moderation” of the last several decades, both growth and inflation remained low but stable. In the post-GFC period the standard deviation of monthly inflation readings was 0.07%, less than half the long-term average. Today, inflation volatility is at a multi-decade high and almost certain to continue to climb (see Chart 1).
Chart 1 U.S. Monthly Inflation Volatility 1957 to Present
While the link between market returns and inflation is less significant than many imagine, a more volatile inflation backdrop is a headwind when it comes to valuations. In the past, equity investors have been less willing to put a premium valuation on stocks when inflation volatility was elevated, as is the case today. And while historically low rates probably insulate stocks from significant multiple contraction, higher macro volatility will make higher valuations less likely.
Earnings carry the day
With multiple expansion harder to come by, earnings drive markets. We saw this dynamic play out in 2021; earnings, not multiples, were responsible for stock market performance. In this regime, the key will be finding industries and stocks that can use rising prices to their advantage.
Not surprisingly, the sectors with the best relative performance when inflation is accelerating are cyclicals, more specifically energy, material stocks and industrials. Interestingly, financials did not make the cut. One reason may be that while financials tend to outperform when rates are rising, as recent history has demonstrated, inflation and interest rates can diverge for extended periods.
Of the cyclical sectors where the relationship was significant, oil & exploration, metals & mining and transport were three of the industries that benefited the most from accelerating inflation. The take-away for investors is this: Inflation can be a headwind for the broader market, but it can also be a tailwind for the right stocks.
Originally Posted on January 10, 2022 – Navigating the New World of Inflation
© 2022 BlackRock, Inc. All rights reserved.
Investing involves risks including possible loss of principal.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of November 2021 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.
The BlackRock Model Portfolios are provided for illustrative and educational purposes only, do not constitute research, investment advice or a fiduciary investment recommendation from BlackRock to any client of a third party financial advisor (each, a “Financial Advisor”), and are intended for use only by such Financial Advisor as a resource to help build a portfolio or as an input in the development of investment advice from such Financial Advisor to its own clients and shall not be the sole or primary basis for such Financial Advisor’s recommendation and/or decision. Such Financial Advisors are responsible for making their own independent fiduciary judgment as to how to use the BlackRock Model Portfolios and/or whether to implement any trades for their clients. BlackRock does not have investment discretion over, or place trade orders for, any portfolios or accounts derived from the BlackRock Model Portfolios. BlackRock is not responsible for determining the appropriateness or suitability of the BlackRock Model Portfolios or any of the securities included therein for any client of a Financial Advisor. Information and other marketing materials provided by BlackRock concerning the BlackRock Model Portfolios –including holdings, performance, and other characteristics –may vary materially from any portfolios or accounts derived from the BlackRock Model Portfolios. Any performance shown for the BlackRock Model Portfolios does not include brokerage fees, commissions, or any overlay fee for portfolio management, which would further reduce returns. There is no guarantee that any investment strategy will be successful or achieve any particular level of results. The BlackRock Model Portfolios themselves are not funds. The BlackRock Model Portfolios, allocations, and data are subject to change.
For financial professionals: BlackRock’s role is limited to providing you or your firm (collectively, the “Advisor”) with non-discretionary investment advice in the form of model portfolios in connection with its management of its clients’ accounts. The implementation of, or reliance on, a Managed Portfolio Strategy is left to the discretion of the Advisor. BlackRock is not responsible for determining the securities to be purchased, held and sold for a client’s account(s), nor is BlackRock responsible for determining the suitability or appropriateness of a Managed Portfolio Strategy or any securities included therein for any of the Advisor’s clients. BlackRock does not place trade orders for any of the Advisor’s clients’ account(s). Information and other marketing materials provided to you by BlackRock concerning a Managed Portfolio Strategy—including holdings, performance and other characteristics–may not be indicative of a client’s actual experience from an account managed in accordance with the strategy.
For investors: BlackRock’s role is limited to providing your Advisor with non-discretionary investment advice in the form of model portfolios in connection with its management of its clients’ accounts. The implementation of, or reliance on, a Managed Portfolio Strategy is left to the discretion of your Advisor. BlackRock is not responsible for determining the securities to be purchased, held and sold for your account(s), nor is BlackRock responsible for determining the suitability or appropriateness of a Managed Portfolio Strategy or any securities included therein. BlackRock does not place trade orders for any Managed Portfolio Strategy account. Information and other marketing materials provided to you by BlackRock concerning a Managed Portfolio Strategy—including holdings, performance and other characteristics—may not be indicative of a client’s actual experience from an account managed in accordance with the strategy. This material is subject to change.
Prepared by BlackRock Investments, LLC, member FINRA.
©2022 BlackRock, Inc. All rights reserved. BLACKROCK is a trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.
©2022 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from BlackRock and is being posted with permission from BlackRock. The views expressed in this material are solely those of the author and/or BlackRock and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.
Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.