The five giants of Wall Street’s “inflation defense” tactics are wide open

Rising Inflation after the unsealing of the Epidemic is an invisible force rocking Wall Street and could change everything in the world of cross-asset investing. The overheated U.S. economy has caused the market’s inflation expectations to rise to the highest level in more than a decade, so Outside Press interviewed top money managers for their opinions on future hedging strategies.

The core view is that if people believe predictions of runaway inflation, then the trading logic for stocks, real estate and interest rates could change forever.

Yet there is a clear divergence of opinion among different investment banks. Goldman Sachs Group says we have witnessed the strength of commodities for more than a century, while JPMorgan Chase is skeptical, preferring assets such as infrastructure. Meanwhile, Pacific Investment Management warns that market forecasts for inflation are wrong and that central banks could still lower their inflation targets in the next 18 months.

The following is a compilation of key views from five major Wall Street investment banks.

Algebris Investments: Favor hedging instruments including convertible bonds and commodities

At this point we don’t know if inflation will continue to rise, but it’s a good start. What we do know is that the market is completely mispriced. For a decade, investors have been long U.S. Treasuries, investment-grade bonds, Gold and technology stocks, assets that benefited from quantitative easing.

But future investors will turn to real economy assets such as small caps, financials and energy stocks, rather than interest rates and credit, which will create tremendous volatility. We favor value stock convertibles associated with cyclical acceleration. In addition, we also prefer commodities.

Previously central banks drove the economy upward by keeping interest rates low, while governments used economic austerity to put the brakes on the economy, but now governments and central banks are turning in tandem.

JPMorgan: Prefer physical assets to commodities and inflation-protected bonds

Commodities tend to be more volatile and do not necessarily provide good inflation protection. As for index-linked bonds, our research shows that the long-term duration of an index bond outweighs the pure inflation compensation provided by the bond. Index bonds are not the most important asset on our list of inflation hedging instruments.

If inflation continues to rise, which we believe is a low probability, then the recovery equity sector will have a good investment outlook. We are also bullish on real assets and the U.S. dollar.

We expect inflation to be volatile in the short term, especially in the second quarter, due to base effects, excessive demand in the short term, and supply chain disruptions caused by the prolonged embargo. However, we believe this situation is temporary and expect central banks to overcome short-term volatility.

Goldman Sachs Group: Warning on indexed bonds and gold

We find that commodities are the best hedge against a backdrop of high inflation, especially Crude Oil. The history of the last 100 years shows that commodities can protect you from unexpected inflation, which is caused by scarcity of goods and services, or even wage inflation as in the late 60s. The stock market is a mixed bag, but value stocks will do well thanks to their cash flow with short duration.

The biggest surprise is gold. Gold is often seen as the preferred hedge against inflation. But this depends entirely on the Fed’s ability to respond to inflation. If the Fed doesn’t take a shot at long rates, then gold may not be a good choice because real yields could rise. We think indexed bonds are in the same camp as gold.

We don’t think inflation will stay above 3%, but the risk of such higher inflation has certainly increased compared to the last cycle.

Pacific Investment Management: Inflation likely to fall below central bank target over next 18 months

We see low short-term volatility from energy prices and other price components, and the central bank’s inflation target will be difficult to achieve for the next 18 months or so. The global economy has spare capacity to accommodate growing demand. However, if economic spending grows steadily over many years, this could eventually lead to higher inflationary pressures.

We recommend a bond yield curve strategy, with the U.S. inflation-protected TIPS providing reasonable protection against rising inflation. Commodities and real estate-related assets should also benefit in a rising inflation environment.

BlueBay Asset Management: Reducing duration risk and warning about market complacency

Real assets such as real estate and commodities are worth the most in an inflationary scenario. Holding duration exposure to bonds is not attractive because yields will rise in the coming years if inflation is higher than what we are used to. The most overlooked risk is that everyone makes inflation expectations based on what they have seen in the last 5 to 10 years, creating too much complacency.