Positioning portfolios for inflation

A year on from the most dramatic economic effects of the Covid-19 pandemic, investors are watching inflation data as they position their portfolios.

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Michael Sager, vice-president, multi-asset and currency management at CIBC Asset Management, said the base effects from last year’s sudden drop in output are starting to show in economic data.

Just over a year ago, crude oil prices went into negative territory and airline ticket prices crashed. Crude oil is now trading above US$60 per barrel, “a very significant year-on-year positive that will impact consumer prices,” Sager said. “So, at the most trivial level, base effects are going to drive inflation higher.”

U.S. inflation jumped 2.6% in March compared to the previous year, while Canada’s consumer price index was up 2.2% year over year.

But while the base effects will make for dramatic year-over-year changes in second-quarter data — Sager expects headline U.S. inflation to be around 4% — there are other factors driving inflation. These include a weaker U.S. dollar and the Federal Reserve’s willingness to let the economy run hotter as the economy recovers from pandemic lockdowns.

Fed Chair Jerome Powell has repeatedly said the central bank won’t raise rates until after 2023. While inflation figures will rise this spring, he has said the increase will be temporary.

Sager said he expects inflation to slow slightly after Q2 but to remain around 3% year over year for the next couple of years.

“That’s a material change, and it has important implications for how we think about portfolio construction and portfolio positioning,” he said.

Rising inflation hurts bonds and equities, “although we think equities can still continue to go up as an asset class over the next few years,” Sager said.

Still, he said investors should supplement traditional portfolios with other asset classes. These include gold, real estate, infrastructure and cyclical commodities such as oil. Inflation-linked bonds can also help to “hedge exposure and protect against the risk of inflation,” he said.

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Mark Burgess

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Mark was the managing editor of Advisor.ca from 2017 to 2024.