William John Market Report 16-12-21
William John Market Report 16-12-21Category: Reports
As inflation continues to accelerate to its highest level in over a decade, investors are allocating more capital to inflation-linked assets. In November, U.S. inflation rose to 6.8% whilst Eurozone inflation rose to 4.9% and U.K. inflation to 5.1%, all year on year. Whilst Central Banks in question have been paying close attention to inflation, with many tapering back their quantitative easing programmes and are preparing to raise interest rates in a monetary policy reversal, many expect inflation to continue to rise until at least Q2 or Q3 2022.
The longer inflation sustains itself, the greater the urgency for investors to counteract its erosive effect on real returns on dividend income and coupon payments on bonds. Hence, U.S. Tips bond funds have seen their largest inflows on record. Treasury Inflation Protected Securities (Tips) are government bonds issued by the U.S. Department of the Treasury which adjust their coupon payments to the adjusted value of the principal of the bond. The “adjusted” value is calculated in line with changes in the Consumer Price Index – the proxy measure to account for changes in the price level (or inflation). This ensures that nominal investor returns are proportional to the nominal price level, protecting their real returns.
Looking at approximate US Tips annual flows in USD billions since 2003:
Source: William John Analytics, Financial Times, Emerging Portfolio Fund Research
Clearly in recent years Tips bond funds have been on an upward trend, however, there has been a clear acceleration in 2020 and 2021 surrounding the fallout of the COVID-19 pandemic.
Other investments that have seen a rise in popularity alongside rising inflation have been commodities and real estate. Commodities tend to be good inflation hedges, that is, good investments that offset the cost/risk of inflation because energy prices play a pivotal role in the calculation of inflation, and energy prices are linked to the prices of major commodities e.g., Oil, Gas etc. So, energy related commodity prices rise alongside inflation. This is likely to have an impactful growth on fund inflows into energy-related stocks funds or commodity funds over the next year.
Additionally, REITs (Real Estate Investment Trusts), a popular vehicle to channel investor capital into an array of Real Estate investments, have seen stronger investor demand. REITs are also a good inflation hedge because their income is derived from rents on its real estate investments and rents tend to be adjusted to reflect inflation periodically.
Overall, as inflation continues to rise (and is expected to continue to rise) this is starting to have a tangible impact on investor preferences in the financial markets. Commodities and Real Estate funds are expected to benefit from sustained inflation as 2021 draws to a close.
Any opinions expressed in these documents are those of William John and are provided for information only. E&OE.