This Might Be A Good Time To Hedge

This Might Be A Good Time To Hedge
Theodora Lee Joseph, CFA

9 months ago2 mins

Growth has been falling, and historically that might have meant that interest rates would be falling too. But that’s not necessarily going to happen any time soon. In fact, we’ll likely see the reverse: interest rates moving even higher than they are now – or at the very least staying higher for longer – as central banks continue to focus on bringing down inflation, even at the risk of slowing economic growth. And, of course, that’ll have consequences for your portfolio, as the historical relationships between different asset classes shift.

As you can see in the chart, bonds (darker pink bar) tend to deliver positive returns at every stage of the economic cycle. And, historically they’ve played a key role in portfolio diversification because of their negative correlation to stocks. When correlations are negative, one asset rises when the other falls, and vice versa. When growth surprises in a positive way, stocks do well but bonds fare poorly and vice versa. But there are exceptions, and sometimes the correlations break down. Right now, for example, the relationship seems tenuous, mostly because of high inflation, all the recent interest rate increases, and the central bank shift away from huge bond buying, or “quantitative easing” programs. And the longer these factors persist, the more important it becomes to consider using other asset classes in your portfolio as a hedge: like cash and commodities.

When inflation is persistently high, like it is now, it could be helpful to keep more cash instruments in your portfolio. That’s because cash yields would be expected to grow as interest rates increase. Commodities also would be likely to benefit from more persistent inflation, and from other themes like reshoring and escalations in geopolitical tension. Since commodity markets are driven more by supply and demand factors than by growth and inflation shocks, they can help present a good hedge against both stocks and bonds. Again, how you decide what to invest in might depend on which economic stage in the chart you think we’re in, and whether you believe that might be on the cusp of changing.



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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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