Inflation has been at the forefront of investor worries over the last six months, these worries became even more pronounced on May 12th, when the US Consumer Price Index was released, at a level of 4.2% for the month of April. Consumer prices (CPI) are a measure of prices paid by consumers for a market basket of consumer goods and services and the yearly growth rate in CPI represents the inflation rate. The April value was the highest registered value since 2008 and came with a 17% surprise versus the survey average, at 3.6%.
While part of this increase was driven by the reopening of the economy and the comparison to the depressed level of consumption of April last year, in the midst of the lockdown, it is clear that inflation is coming back. This is not coming as a surprise, given the massive amounts of fiscal stimulus pumped into the economy throughout last year and the beginning of this year. The current stimulus package is expected to continue over the next months (employment is still well below the pre-crisis level granting a longer-term stimulus package) and this will continue to support consumption and therefore growth for this year.
What does it mean for portfolios?
Higher inflation translates to higher nominal interest rates and has a negative effect, both on the fixed income space, as well as a part of the equity space.
In Fixed Income, longer duration bonds, in particular, will suffer in an inflationary environment, as the higher nominal rates push down bond prices. For this reason, we have been significantly underweight duration versus the index, with a significant portion of the portfolio maturing over the next few months, in order to be able to reinvest those proceeds at favourable rates. We have also been investing in floating rate notes, as well as inflation linked treasury bonds (TIPS), which are constructed to outperform in a raising inflation environment.
As for equities, markets reacted negatively to the CPI announcement, with both the S&P 500 Index and the Nasdaq Index down more than 2% that day (May 12th). The only sector that ended the day in the positive was energy, as inflation translates to higher energy prices and therefore, to higher revenues for energy companies. After a long period, in which we did not have any energy exposure we seized the opportunity and started adding to this sector.
We thank you for the continued support.