Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, January 21st at 2:00 p.m. in London.
One question we get a lot at the moment is “how can I protect my investments against inflation?”. While Morgan Stanley's economists do expect inflation to moderate this year - actually starting this quarter - the high current readings on inflation have made it a hot topic.
One of the biggest investing challenges with inflation is that when it's truly high and persistent - the kind of inflation that we saw in, say, the 1970s - it's simply bad for everything. That decade saw stocks, bonds and real estate all perform poorly. There was simply nowhere to hide. Still, investors do look at specific strategies to try to hedge inflation. Unfortunately, some of these, we think, have challenges.
One place that investors look to protect against the effects of inflation is precious metals, like gold. But while gold has a very impressive track record of maintaining value throughout thousands of years of human history, its day to day and month to month relationship with inflation is kind of shaky. Gold can actually do worse when interest rates rise because gold, which doesn't provide any income, starts to look worse relative to bonds, which do. And note that over the last six months, when inflation has been elevated, gold hasn't performed particularly well.
Another popular strategy is owning treasury inflation protected securities, or TIPS, which have a payout linked to inflation. I mean, the inflation protection is in the name. Yet if you look at the actual performance of these securities, that inflation protection isn't always so simple. TIPS performed well in 2020, a year when inflation was low, and they performed poorly in 2018 and over the last three months, when inflation was higher. The reason for this is that TIPS are also sensitive to the overall level of interest rates - and if those are going up, they can see their performance suffer.
These two examples are part of the reason that, when we think about protecting portfolios against elevated inflation, what we're often trying to do is to avoid sensitivity to real interest rates, which, at the moment, we think will continue to rise. We think this favors keeping lighter exposure overall, favoring energy over metals and commodities, favoring stocks in Europe and Japan over those in the U.S. and emerging markets, and being underweight real interest rates directly in government bonds.
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