How hot is the inflation pot? Strategies to protect portfolios from inflation risk

As the global economy emerges from its worst slump since the 1930s, we envisage plenty of inflation fertilisers at stake, especially in the United States. Inflationary trends could emerge due to a combination of factors, including the cyclical recovery as countries try to get the pandemic under control and gradually lift mitigation measures. This will come at the same time as a super-sized US fiscal stimulus, thanks to the recently-passed $1.9tn fiscal package, which includes $1,400 direct payments to US citizens earning $75,000 a year or less, which will be disbursed quickly. The cheques could result in a big boost to consumer spending as early as April and could equate to the unfolding of huge pockets of pent-up demand in those sectors which have been hit the most by lockdowns. These trends – which are expected to unfold over the next twelve months – will join forces with more structural trends and a likely regime shift towards higher inflation as a way out of the crisis.

Higher inflation will have huge investment implications and any portfolio construction exercise should be approached with this regime shift in mind. To build an inflation-proof portfolio, investors should consider increasing their allocation to assets such as inflationlinked bonds, real assets mainly real estate and infrastructure and commodities. In bonds, rising bond yields will warrant a cautious and active approach on duration, while searching for income across the entire market spectrum. In equities, higher inflation may dent equity valuations, especially those at highly expensive levels, and favour the multi-year rotation from growth to value stocks. From a cross-asset will be attractive in this respect. perspective, higher inflation will challenge traditional portfolio diversification, as the equity-bond correlation turns positive. Solutions may target real returns with a broad range of asset classes.

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