How to Boost Portfolios When Inflation Runs High

Inflation might have popped over 5% this year, but at least three asset managers appearing at the Morningstar Investment Conference in Chicago on Thursday said they saw inflation slowing sometime in the second or third quarters of 2022.

They provided ideas advisors could use in the meantime to either protect client portfolios from inflation risk or leverage that inflation for gain.

During a session called “How to Protect Your Portfolio Against Inflation,” Morningstar manager research analyst Bobby Blue interviewed Nic Johnson, Pimco managing director and lead portfolio manager on its commodity funds; Catherine LeGraw, GMO asset allocation specialist; and Evan Rudy, DWS lead portfolio manager for its real asset strategy.

Here are six takeaways from these experts.

1. Inflation isn’t too worrisome — yet.

Pimco’s Johnson noted that “factors that are very localized and one-off price level adjustments … such as used cars” have been driving up the Consumer price Index in the past few months. He noted these type of jumps are more due to pent-up demand amid the economic reopening and supply chain issues, like semiconductor chip shortages.

“The question is how much of the spike [in inflation] will normalize back to the Fed’s target of 2%,” he said, adding that Pimco believes it’s at peak now, and will “normalize” to 3%-3.5% or something closer to to 2%-2.5%.

GMO doesn’t see inflation spiraling out of control, as workers lack “sufficient power” to cause continual wage increases, LeGraw said. In fact, one of her colleagues developed a “worker-power” index, and at this point, the index is “quite low relative to history,” she said. “Now that could be in transition, but right now we really feel skeptical that wages are going to run out of control and inflation will take off.”

2. Despite the escalating housing market, rents aren’t matching the jump, and probably won’t.

Rudy pointed out that in 2006-2007, housing prices rose 15%, while owner’s equivalent rent rose about 4.5%. Today, median home prices are up about 17% while OER is up about 2.5%. He says it’s possible that supply disruptions are “more persistent than we thought,” which could cause higher inflation in the future, but he believes they will ease.

Johnson added that “lower interest rates increase home prices, but they create a more muted effect because it has a lower cost in servicing that asset, that debt on a home, and it means that rents don’t have to rise as fast.”

3. Fiscal and monetary stimulus is net neutral as far as spurring inflation.

LeGraw said that more money chasing more goods should be inflationary, “but [fiscal stimulus] has been a replacement for lost income … and any excess has been dumped into the stock market, [therefore] not competing for goods and services.”

4. Supply shortages probably will be short term and then disperse.

Johnson equated the current supply chain disruptions to a marathon, in which runners are all gathered together before the gun goes off and find their pace and disperse as the race goes on. He said the same is most likely to happen with pent-up demand from the pandemic.

This, too, is affecting the higher CPI that Pimco expects will come down. “It’s taken longer than we expected,” he said. “[But] when we look at our bottom-up CPI forecasts, we still think the direction is right and it’s ultimately transitory without a magic silver bullet other than the passage of time.”

5. Equities are a great buy in inflationary times.

“The beautiful thing about equities is they are a real asset, so they retain their real value through time,” LeGraw said. However, in an inflationary environment, re-ratings happen, which can be “acutely painful” in the short term. The solution, she said, is to manage inflation risk by buying cheaper stocks.

“They’re less vulnerable to re-rating,” she said. “[Also] natural resource equities are a pretty brilliant asset within equities. They’ve got this strong, fundamental link to inflation and today they are wonderfully cheap.”

Johnson agreed, adding that during times of risk around inflation, “consider how to build a more balanced portfolio or [determine] what to add as ballast.” He agrees national resource equities are good, but so are commodities and real estate.

6. The jury is out on gold or cryptocurrencies protecting portfolios.

“The best way for everybody to think about gold is as a very, very long duration real asset,” Johnson said. “It will keep pacing inflation over very long periods of time.” That said, he believes it has underperformed in today’s inflationary markets but may make sense as a long-term allocation.

LeGraw said that she has difficulty having an asset that has no asset flows. “So that’s one of our struggles with gold. I would say crypto takes that to the next level in struggling with valuation,” she said. “It really has no fundamental anchor. You’re essentially liking cryptocurrencies because you believe the next guy is going to like them more than you did … we just steer clear of that.”