Bonds have served as stocks’ wingman for decades, providing protection from corrections as well as stable income. That worked while the Federal Reserve’s focus was on low and stable inflation. But now its monetary policy aims to lift inflation and maximize employment, which means a regime change for investors.
Specifically, the traditional portfolio mix of 60% equities and 40% fixed-income securities requires a rethink in a period of rising inflation, as we’ve discussed before. No longer can bond yields be reliably expected to drop (and bond prices to rise) when interest rates are historically low and inflation is moving higher.
Better hedges for stocks than bonds now are inflation hedges, according to Bank of America rates strategists Meghan Swiber and Bruno Braizinha. Looking back at the record since 1990, Treasuries provided excellent diversification for a stock portfolio while inflation ran below 2%, they write. But when inflation runs hotter, as it is now, Treasury inflation-protected securities and commodities were better diversifiers.
The focus on inflation has meant stock and bond prices move together, rather than counter to each other as in the past, which has significant implications for asset allocation, according to a tracking report from Deutsche Bank.
As a result, flows into TIPS sector funds are running at the strongest pace since 2018, attracting a net inflow of over $30 billion in that span after having been negative a year ago. Similar strong inflows were seen into materials and energy funds, benefiting from a boost in prices in those sectors. Financials also were seen as an inflation beneficiary from the rise in intermediate- and longer-term interest rates. A more upwardly sloping yield curve typically is a plus for banks and other financial institutions.
TIPS breakeven rates (the inflation compensation, derived from the difference between the nominal yield on a Treasury note and the real yield on corresponding TIPS maturity) are around 2.5%, the high end of their historic bands, Deutsche Bank points out. And internet searches for “inflation” and “hyperinflation” also are running at record highs, the report adds.
During periods when inflation surprises on the upside by 1% or more, investments such as commodities, gold, and equities of resource producers have performed best, according to a report from Glenmede Trust, making ‘real assets’ the best protection against such inflation risks, it adds.
Real estate investment trusts also offer attractive valuations. Glenmede’s proprietary model…