Much of this year, the U.S. has seen low growth, easy monetary policy and low inflation.

But, Maura Murphy, vice president at Loomis Sayles, is starting to see a shift.

“The assets that were winning for much of the year were yield-seeking assets – going into high yields; going into emerging markets; thinking about more defensive sectors in the U.S. equity market, like Staples or REITs or utilities (things that are more rate-sensitive),” Murphy said during a press luncheon featuring top investment experts from Natixis Global Asset Management’s affiliate asset managers. “But we think we’ve seen a shift since the start of the third quarter. We’ve seen a massive sector rotation from defense into pro-growth and pro-cyclical.”

One area where that shift is already hitting is REITs. Over the last three months, according to Murphy, REITs underperformed financials by 10%.

“We haven’t had that in three or four years, and we think that’s because people are starting to price in higher rates, higher growth and a better inflation outlook,” she said.

Murphy, who is co-portfolio manager of Loomis Sayles Multi-Asset Income Fund and Loomis Sayles Inflation Protected Securities Fund, said they’ve taken REITs down to zero from 25% at the start of the year in the Loomis multi-asset portfolio.

“That’s a big shift for us, and we’re willing to stick our neck out and make that bet because of the signs that we’re seeing out there,” Murphy said. “Growth is picking up in the U.S., and inflation is set to pick up quite substantially actually just with the change in oil prices in the last year.”

In mid-October, the Consumer Price Index, before seasonal adjustments, showed inflation rising at 1.5% over the past 12 months, according to the U.S. Bureau of Labor Statistics

“If oil stays at [$50 per barrel] for the next three months, we add 1% to inflation,” Murphy said. “That’s a huge change and that’s literally just the negative roll-off of where oil was last year versus where it is this year. And then if we start to see any sort of more medical inflation costs rise or wage inflation start to pop up or rent inflation pick up – you could really start to see that data move higher very quickly.”

How does the Federal Reserve respond to a rising inflation? Murphy expects the Fed will hike in December, but after that “they will be cautious.”

“They would rather let inflation run hot then risk scaring the market by hiking too quickly,” she said.

What worries David Lafferty, SVP and Chief Market Strategist at Natixis Global Asset Management, is how the markets will react to a rising inflation.

“The rolling off of the energy numbers and potentially driving the headline CPI numbers up 1% – the thing that’s most interesting about that to me is that I don’t think the market is priced for that,” Lafferty said during the press luncheon.

Lafferty said he’s less worried about what the Federal Reserve will do and more worried about what the market does.

“For years and years and years financial advisors have been plugging 3% into their inflationary calculation into all their models up until about six or seven years ago, and now we’ve been living in this world where inflation is 1-1.5% and just like interest rates being lower for longer, nobody seems to be worried about inflation anymore,” Lafferty said.

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