Inflation Should Stay Higher, And That Matters For Stocks

Inflation Should Stay Higher, And That Matters For Stocks
Theodora Lee Joseph, CFA

2 months ago2 mins

This past year was full of curveballs: the anticipated US recession never arrived, economies showed unexpected resilience, and inflation decided to give us a break. But don't let that fool you: even though inflation seems under control in most developed countries, it's likely to settle at a higher rate than the last decade – and that matters for your portfolio.

Industries are changing, not least because governments are pushing toward clean energy. Global supply chains are evolving, while "nearshoring" – the practice of moving production closer to customers – might put a floor under the prices of goods and make them more likely to rise higher. And in a classic case of a self-fulfilling prophecy, shoppers’ expectations of higher costs may allow retailers to pull out the pricing guns. Indicators of future inflation already show that investors expect US and eurozone inflation to land between 2% and 2.5% over the next 5 to 10 years, up from the 1.5% to 2.0% range set between 2015 to 2020.

Now, the good news: history says stocks do well when inflation is between 2 to 3 percent. In fact, the average S&P 500 return is nearly 14% when inflation is in that range. And it's not just stocks: real assets like global real estate, infrastructure, transportation, commodities, and timber could also benefit in that environment

Let’s not forget bonds. They’re likely to do well as central banks cut rates, and because we’re starting from a high point, the upside is greater than the downside. Check it out: if rates rise by 1% over the next year, ten-year US Treasury bonds would take a 2% hit. But if rates fall 1% over the next year, the same bond rises by over 12%.

In a nutshell, higher rates shouldn’t scare you off investing. If you want to play it safe and minimize risk, you could swap out some stocks for bonds. But if you're aiming to capture as much potential as possible, holding onto stocks could be the way to go. Ultimately, the key is to stick to your strategic asset allocations and look forward to the stronger returns expected in the future.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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