Market commentary: Fears about rising inflation could negatively impact portfolios

Talk of rising inflation over the coming years has intensified in recent months but deVere Group CEO, Nigel Green, has warned that heightened fears about inflation are “overplayed” and could negatively impact investors’ portfolios.

In December 2020, European Pensions reported on a report by Nuveen, which said pension funds and other institutional investors should be aware of the risks of a “burst of inflation” over the coming years, which is now more likely due to current monetary policies as a result of the pandemic. In addition, AXA IM has previously warned pension schemes to look at increasing their inflation hedging before a “big inflation shock”.

However, Green’s caution over inflation fears comes as the U.S. Federal Reserve this week upgraded its growth forecast to 6.5 per cent from 4.2 per cent previously for 2021.

Green said: “As the world increasingly looks towards a post-pandemic global economic rebound, inflation fears have been heightened in recent weeks. These concerns are now likely to be exacerbated as the Fed, the central bank responsible for the world’s largest economy, has dramatically upgraded its outlook. This can be expected to further fuel rhetoric about inflation.

“It will be argued by some that as inflation climbs, we will have higher interest rates and this could lead to lower stock prices. I think that we should expect a short-term jump in prices as economies re-open, however, longer-term inflation fears, due to pent-up demand are premature and are being overplayed.”

He added that investors should certainly “keep an eye on inflation”, but the fear of it is “arguably more dangerous to investors than inflation itself” as they could be put off investing in stock markets, meaning they could miss out on good returns during the economic rebound.

His thoughts were echoed by Quilter Investors portfolio manager, Sacha Chorley, who said investors are “worrying about the wrong thing when it comes to recent market movements”.

“Bond yields have risen sharply and growth equities have sold off as investors appeared to become concerned about a looming uptick in inflation as lockdowns ease and economies normalise.” This has seen some abrupt market movements, however, Chorley believes this fear of inflation has been misplaced and has not been the one driving markets in recent weeks.

“The commentary suggests investors are worrying about a return to an inflationary environment as a result of the overwhelming monetary and fiscal support that has been required to prop up the global economy,” he said. “Coupled with lockdowns easing and mass vaccinations, there are concerns we will see inflation return. But market movements have not been driven by inflation prospects, rather the rise in real yields we have seen across the board.

“If you look at market based expectations for inflation, it is true that indications are above the 2 per cent target many central banks set. But crucially it has been a steady increase since 2020 rather than a sharp rise, and the latest drop in markets actually coincided with a decrease in these inflation expectations.

“Indeed, the Federal Reserve has not changed its guidance on inflation, so these fears do appear slightly misplaced just now.” Chorley is unconvinced we will see a sharp rise in inflation when demand does return.

“Inflation does have the potential to rise but there are structural issues at play here that have been created by the pandemic. Unemployment has begun to creep up and once support schemes are withdrawn it is likely to keep climbing. Part-time employees are out of work just now, so there are multiple cohorts that will not be in a position to spend as the economy opens up.

“Furthermore, a lot of emphasis is being put on the mass of savings that has been accumulated during lockdowns. But there is no guarantee this cash pile will be spent, especially given the accumulation has largely occurred in wealthier households. With uncertainty abound many will sit on these cash buffers in case the worst happens to their situation.

“Central Banks will also ensure inflation does not get out of control and have plenty of room in their policy arsenal to crush any spikes.”

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