How stocks and other financial assets behave when inflation rises

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Oil prices have been above $ 70 a barrel in recent times, climbing nearly 50% on the year as more of the global economy emerges from pandemic lockdowns and picks up steam.

But the mid-year gains shouldn’t come as a complete shock either, given the past outperformance of crude versus stocks and other financial assets when the cost of living rose.

“Our research shows that investments associated with tangible assets may be an option for investors concerned about higher inflation,” wrote Chao Ma of the Wells Fargo Investment Institute, a global portfolio strategist, in a note Tuesday.

The following chart shows Ma’s findings that as inflation rises, oil prices outperformed with a gain of 41%, followed by emerging market equities at 18%, while gold GC00,
-2.61%
and cyclical stocks both climbed 16%

What has risen the most with inflation? Oil.

Wells Fargo Investment

To compile the tally, Ma has been tracking asset prices during periods when the consumer price index has risen more than 0.3% on a monthly basis, over the past two decades or so. The two sectors that produced negative prices during periods of inflation were emerging market fixed income and investment grade fixed income.

To verify: The Fed must say “it will not buy any more corporate bonds” to break the “feedback loop”, says this bond CIO

To be sure, financial markets have been in a tear for the past 15 months, aided by trillions of dollars in pandemic fiscal and monetary stimulus spilling over into the U.S. economy. A key question will be: how far can assets climb?

Stocks as a group have generated “impressive returns” relative to fixed income in past periods of rising prices, enough to outpace the impact of inflation, according to Ma, who called past periods of economic expansion and rising interest rates’ a backdrop very similar to the one we see. now.”

A notable exception in the past was inflation-protected Treasury securities, Ma wrote. The TIP iShares TIPS Bond ETF,
-0.29%,
which tracks T-bills indexed to inflation with at least one year to maturity, was up 0.4% on Tuesday, but down 0.2% on the year.

Investors recently considered how best to position themselves against inflation, whether long-lasting or temporary, as well as the possible withdrawal of extremely accommodative monetary policy during the pandemic.

A more hawkish update of Federal Reserve policy last week caused the DXY dollar to fluctuate,
+ 0.62%,
the US Treasury market TMUBMUSD10Y,
1.296%,
stocks and other financial assets. After the sharp drop in stocks last week on Tuesday, stock indexes, including the Dow DJIA, have
+ 0.43%,
S&P 500 SPX,
+ 0.21%
and Nasdaq Composite COMP,
-0.36%
were growing higher for a second day.

World benchmark Brent BRN00,
-0.77%
Futures also briefly exceeded $ 75 a barrel on Tuesday for the first time in more than two years, while US benchmark West Texas Intermediate CL00 crude,
-1.11%
was trading at almost $ 72 a barrel.

Brent crude could hit $ 80 a barrel in the third quarter of this year, according to a new forecast from BNP Paribas, which expects prices to drop to $ 70 by the end of 2022. For WTI, the bank calls for a record price of $ 77.5 a barrel. barrel on the same stretch, before falling to $ 67.

“Overall, we favor equities in the current environment of economic expansion and rising inflation,” Ma wrote, adding that Wells’ preference is for cyclical equity sectors, especially financials, industries, materials, communication services and energy, but also American small caps. RUT actions,
+ 0.55%
and emerging market equities.

See: Fear of inflation? The best (and worst) performing stocks when prices rise


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