MARKETS & INVESTING
YOUR GUIDE TO INVESTING IN AN INFLATIONARY WORLD
Chris Forgan Portfolio Manager Fidelity
It ’ s clear that investors are concerned about inflation for a range of reasons . Here , we take a look at the key reasons inflation is an important driver of markets , how different asset classes fare in an inflationary environment and how we think about managing inflation within our multi-asset portfolios . The period defined by low inflation and ever-decreasing interest rates prevalent in developed markets over much of the previous four decades seems to be over . In the post-Covid era , inflation has been rising and central banks are hiking interest rates across most key economies to tame recent high inflation . This has understandably been a worry for investors due to increased volatility and correlation of financial assets , as experienced during the first half of 2022 , when both equity and bond markets fell simultaneously . On the fixed income side , there are worries that higher inflation could erode the diversification benefits of bonds and diminish real returns . On the equity side , there is a concern that interest rate hikes could push economies into recession , which poses significant risk for equity market valuations .
Why inflation is important for investors A moderate level of inflation stimulates the economy by encouraging people to spend . An individual is unlikely to defer a purchase in the knowledge that it will cost more in the future . So this incentive to spend increases the demand for goods and services and , in turn , stimulates the economy . Inflation is one of the main reasons why investors invest : because holding cash reduces your future purchasing power given the impact of rising prices . This fact is even more relevant in the current high inflationary environment .
Real returns ( nominal returns minus the rate of inflation ) are what investors should care about , and inflation is detrimental for real returns . The only choice for an investor to maintain purchasing power in the long term is to generate returns which outpace inflation .
Equities remain a long-term bet against inflation , but selection is the key Over longer time horizons , equities provide the greatest chance of achieving a positive risk-adjusted return . Because a company ’ s revenues and profits should grow with inflation after a period of adjustment , this asset class is often a strong component of a portfolio designed to provide growth over the long term .
However , not all equity sectors generate returns in the same way in a highinflationary environment . Sectors that deal directly with consumers , such as consumer discretionary and automobiles ( among others ), are impacted negatively . As pricing power is now weakening , companies ’ margins are coming under pressure . On the other hand , value segments of the market ( such as the financials and materials sectors ) benefit the most from high inflation . Elsewhere , sectors such as healthcare benefit due to strong pricing power and resilient earnings . At a regional level , core inflation remains stubborn and high in developed markets . Conversely , several emerging markets have subdued inflation and investors are being rewarded with positive returns from just owning investments .
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