Here at Silicon Hills Wealth Management, we have been listening to the concerns of our clients regarding inflationary pressures in markets and the impact it may have on specific asset classes and portfolio performance moving forward. Our investment committee recently came across some fantastic research from a group of researchers at The Man Group, a global investment management firm based out of London. 1
We wanted to summarize some key insights from the paper and address the following questions:
- Why investors should be considering the impacts of inflation on assets moving forward
- How inflation affects different asset classes
- Actions investors can take to add durability to their portfolios against inflationary pressures
1 Neville, Henry and Draaisma, Teun and Funnell, Ben and Harvey, Campbell R. and van Hemert, Otto, The Best Strategies for Inflationary Times (April 28, 2021). Available at SSRN: https://ssrn.com/abstract=3813202 or http://dx.doi.org/10.2139/ssrn.3813202
Why should investors be considering the impacts of inflation on assets moving forward?
Given the unprecedented stimulus over the past 12 months to combat the Covid-19 pandemic on top of the fiscally accommodative policies of both Congress and the Federal Reserve since the “Great Financial Crisis”, it is understandable that investors are keeping the concerns of inflationary pressures top of mind looking forward. From February 2020 through February 2021, the US money supply increased from $15.5 trillion to $19.7 trillion, an overall increase of $4.2 trillion. Below is a graph from the Federal Reserve Bank of St. Louis showing the money supply over time going back 30+ years, the red circle highlights that recent increase of $4.24 trillion.
On top of the increase in the money supply, the recent stimulus will put the US deficit at roughly $3.1 trillion for 2020 and $2.3 trillion in 2021, both numbers are over 10% of GDP which raises concerns. In recent modern history of the US, only twice before has the US run a deficit in the double digits as a percentage of GDP and both of those times coincided with a World War (both I & II). In combination with the rise in the money supply and large fiscal deficits, the financial markets are pricing in a higher probability of rising inflation moving forward as seen by analyzing the bond market (longer term yields are rising) and the derivatives market (31% probability of >3% inflation over next 5 years).
How inflation affects different asset classes
If investors have reason to believe that inflationary pressures may present themselves in financial markets, the next focus should be on analyzing how different asset classes performed during those periods. The researchers use a 5% year-over-year increase in inflation to define inflationary periods in US market data. In order to increase the robustness of the research, the paper also incorporates data starting in 1926 and includes prices across three markets (US, UK, and Japan). Below is a table summarizing key asset classes and their performance:
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