We’ll get through this. Meanwhile…

Until inflation moderates, as we expect, investors might consider a few portfolio adjustments

Having dominated headlines and conversations for much of the past year, news that inflation in the U.S. reached 7% in 2021— a 39-year high — was hardly a surprise. A spike in inflation was widely anticipated as part of the post-COVID recovery. But the scope and magnitude of this is once-in-a-lifetime phenomenon proved to be greater than most anticipated. And the most poignant question, sparking anxiety, conjecture, and heated opinions, remains: how long will this last?

The unfortunate and unavoidable fact is that reconciling the confluence of disrupted supply chains, persistently high consumer demand, and the flood of money arising from rising wages, historically low interest rates and government stimulus payments is no simple task.

LONGER TERM: THIS, TOO, WILL PASS

Our analysts expect inflation to moderate to an annualized rate of 1.7% over the next five years. They note, however, “that masks elevated inflation over the next year-plus that then falls to disappointing inflation in the back years.” The unfortunate and unavoidable fact is that reconciling the confluence of disrupted supply chains, persistently high consumer demand, and the flood of money arising from rising wages, historically low interest rates and government stimulus payments is no simple task.

Against this backdrop, Northern Trust’s Capital Markets Assumption Working Group sees reason for optimism: “While the ‘demand drivers’ witnessed over the past year — importantly the massive infusion of government stimulus — will not persist, the ‘supply enablers’ introduced during the pandemic will. These “supply enablers” include productivity enhancers the pandemic forced upon (and ultimately embraced by) companies and workers. Indeed, one pandemic outcome has been the fuller realization of the power of technology. For a sense of the productivity impact, U.S. real economic output eclipsed its pre-pandemic high in the second quarter of 2021 — achieved with 6.2 million (or 4.1%) fewer workers.

Well Get Through This_Forecast

SHORTER TERM: BUFFERING INFLATION’S IMPACT

Incorporating exposure to certain asset classes may help to mitigate the corrosive effects of inflation on a traditional stock and/or bond portfolio.

Different sectors of the economy will respond differently – at varying rates and timeframes.

 

Well Get Through This_Equity
Well Get Through This_Fixed Income

We discourage investors from viewing any potential inflation-hedging component in isolation. Different sectors of the economy will respond differently – at varying rates and timeframes. For this reason, these strategies should be well diversified.


DEFINITIONS

Correlation is the degree to which two variables move in coordination with one-another.

Hedging is strategically using financial instruments or market strategies to offset the risk of any adverse price movements.

High-yield bonds are corporate debt securities that pay higher interest rates because they have lower credit ratings than investment-grade bonds.

Real estate investment trusts (REITs) are companies that own, operate, or finance income-generating real estate.

Treasury Inflation-Protected Securities (TIPS) are designed to provide protection against inflation. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index.

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