Our investment professionals share and challenge each other’s views, creating a diverse marketplace of ideas for the Wellington Blog.
Today’s record gas prices in Europe and Asia come with wide-ranging ramifications that investors need to be aware of.
Natural gas has been cheap for so long that investors and policymakers may have underestimated its pivotal role in modern-day economies. Now a combination of factors is driving steep increases in European and Asian power prices with the real possibility of shortages. Looking beyond the immediate repercussions we see significant investment implications.
In the short run, high power prices could mean:
There is a sense that the world is slowly “getting back to normal,” after more than a year of COVID-induced economic lockdowns and other restrictions. Unfortunately, many countries — and even some parts of the US — are still grappling with more contagious and virulent strains of the virus (e.g., the so-called “Delta variant”) and troublingly low COVID vaccination rates. We are not out of the woods yet. But broadly speaking, the global economy has been recovering with the aid of accommodative fiscal and monetary policy, supporting the strong performance of risk assets and the ongoing rotation from growth- to value-oriented exposures.
The threat of rising inflation is a bogeyman now. Amid supply/demand imbalances in labor and other factors, we believe inflationary pressures are likely to persist in the period ahead. Against this backdrop, our investment outlook remains largely pro-risk, but is tempered to some degree by what we see as…
As I consider various potential sources of market volatility over the coming months, the one I believe poses the biggest threat to today’s constructive backdrop for risk assets is so-called “bad inflation.” The costs of intermediate goods and inputs to production are climbing at their fastest pace in decades, which presents a likely headwind to corporate profit margins. Additionally, commodity prices are all rising in unison, be it coffee, corn, lumber, sugar, wheat, or gasoline, further straining corporate and consumer budgets.
The US Federal Reserve (Fed) has repeatedly stated its intention to “look through” the inflationary surge we’re seeing today, which it views as transitory. The Fed seems to assume that supply will quickly come back online as the economy reopens and recovers, allowing pricing pressures to abate. I hold a different view. I suspect that productive capacity for commodities in particular will not bounce back as swiftly as the Fed is forecasting. To be clear, I believe much of today’s bad inflation is being driven, either directly or indirectly, by these rising commodity prices and will therefore prove “stickier” and more stubborn than the Fed expects.
As I see it, the public companies that have been rewarded the most over the past decade have behaved more or less like rent-seeking monopolies. Many investors covet steady, predictable cash flows to which they can apply a low discount rate. Conversely, some of the best…
Inflation has become a top-of-mind topic for clients in recent months, with many exploring ways to position for potentially higher inflation in the period ahead. However, after a decade of “disinflation,” we believe the investment community continues to anchor to the prior regime and to some stubborn misconceptions around inflation hedging. Here are five that could prove costly if, in fact, inflation does rise.
Misconception #1: You can wait to allocate to inflation hedges until we have higher inflation.
Reality: Timing when to buy inflation-related assets is just as difficult as trying to “market time” any other type of investment. That’s why investors are advised to hold strategically diversifying assets like stocks and bonds and, in our view, should also own inflation-sensitive assets as a long-term, strategic portfolio allocation. As with any asset, the fundamentals are…
The short answer is not right now, but potentially down the road. And I believe it’s less about how high inflation can go than it is about the portfolio implications of even moderately higher global inflation, which investors haven’t experienced for most of the past 30 years.
It may seem odd to talk about inflation these days. However, the substantial level of coordination between monetary and fiscal policymaking following the COVID-19 shock, with many central banks providing ample space for fiscal stimuli by buying up newly issued debt, has led to inflation coming up in many discussions with clients lately. A string of recent data releases has also helped put inflation risk back on some clients’ radars.
Nonetheless, I think it’s fair to say that many clients remain to be convinced that inflation poses a real threat to their investment portfolios, particularly because…
As I observed in my January 2020 publication, “The lost decade for commodities”, the roll yield1 — the cost of carry, or the return associated with “rolling” a short-term futures contract into a longer-dated contract — has been a persistent headwind for commodities over the past decade. In fact, negative roll yields were the leading detractor from commodities’ performance during the 10-year period ended 31 December 2019.
But history shows that the roll yield hasn’t always exerted such a drag on the asset class. On the contrary, looking at commodity returns by decade, roll yield was actually a positive contributor to the performance of the S&P Goldman Sachs Commodity Index in the 1970s and 1980s and only modestly…
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