- As the global economic recovery continues to pick up steam, concerns over inflationary pressures are growing. So have markets underestimated the risk of inflation or has it largely been priced in? Joining me to talk more about this is Jing Roy, portfolio manager at TD Asset Management. Jing, what's been driving US inflation higher lately?
- We see broadly two forces behind it-- first of all, with the rapid vaccine rollout, the US economy is opening up. Couple that with a large pool of household savings accumulated during lockdown, what you get is the surge in products, a surge in demand in products, which is now outstripping the supply and pushing the prices up. Adding fuel to the fire, recent supply disruptions are causing shortages across a variety of products, including computer chips, spare parts, and sneakers.
The other reason is, really, the higher commodity price is pushing up the input prices, which is being passed on to consumer through higher prices. The prices of oil, copper, and corn have all gone up quite a bit in the past year. What's interesting, though, is that wage inflation is largely absent from the mix.
- So given that backdrop, is inflationary temporary or is it here to stay?
- I think inflation will keep going up in the next 12 month. But what's more important is that it will remain anchored. There's still quite a bit of excess capacity in the economy. And with time, production and shipping capacity will expand to meet a higher demand.
Right now in the market, there's a debate over whether inflation, rising inflation, is permanent or a transitory phenomenon. We are in the transitory camp. But if this debate heats up, I would expect to see higher interest rate volatilities and equity volatilities.
- And how could various asset markets be impacted by higher inflation?
- In a nutshell, bond suffers, but equity thrives, when interest rate and inflation increases moderately from the current level. So bond investors not only have to contend with the loss of capital. Their purchasing power is also being pared by higher inflation over time.
Equities, on the other hand, can participate in the cyclical upturn and grow cash flows faster than inflation. And within equities, we're seeing cyclical companies pulling ahead of growth ones. Specifically, we're seeing energies, banks, and industrials pulling ahead of tech and have outperformed tech by a large margin of six months.
And within each sector, we're seeing the same dynamics happening as well. Take technology, for example. Semiconductors have outperformed software as well as hypergrowth, but loss-making companies.
- So given the shift or this rotation from growth to value, should we still own growth stocks at this point?
- Growth is still a good place to be. For us, growth actually offers capital appreciation. Growth companies that can consistently beat market expectations are in a very good position to offer capital growth over time. Within the growth names, I like those operating in the payment, EV infrastructure, and property technology sectors.
The second reason is really because owning growth is good risk management. Growth stocks and cyclical stocks have low correlations with each other. So having both of them in your portfolio actually smooth out a path of your investment returns, especially when there's gyration in the market as well as that expectation for inflation and growth ebb and flow.
In order to participate in this growth, we typically use hybrid securities and option strategies to protect and limit a short-term downside. At the same time, we need to be extremely cognizant of any signs of inflation spirals because that will force the Federal Reserve to take aggressive action and stop the asset prices in the process.
What we do is to buy put options on broad market indices and incorporate additional less correlated assets, such as foreign exchange and commodities, to help manage that risk.
- So what should investors focus on going forward?
- I can see two ways to invest in this environment. First of all, we really need to allocate assets tactically and hold a diversified portfolio. Secondly, we should also use public alternative strategies to help preserve capital and access growth.
- Jing, thank you very much for your time.