Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 205

From deflation fears to inflation worries

Over the past three years, inflation expectations have come full circle, falling significantly in mid-2014, rebounding from a low in February 2016, and stabilizing in 2017. Contrary to some market commentary, we believe that the US economy has reached the point where the risk for inflation is substantially tilted to the upside.

This shift to an environment in which inflation may return to more normal levels has important implications for investors. An allocation to real assets can protect against inflation and diversify a portfolio while generating current income and offering capital appreciation.

Emerging inflationary pressures

Measures of core inflation (which excludes volatile energy and food prices so more accurately reflects underlying inflation) gradually began to rise in the second half of 2015, as the US economy continued its long recovery from the GFC. The year-on-year change in the core Personal Consumption Expenditures (PCE) price index (the preferred measure of the Federal Reserve) rebounded from a near-term low of 1.3% in July 2015 to 1.8% in February 2017. The year-on-year change in the core Consumer Price Index (CPI) rose as well, from 1.6% in December 2014 to a range of 2.0%–2.3% over the past year.

This acceleration in inflation has been slow in part due to the plunge in oil prices and the rapid strengthening of the US dollar, but the recent rise in core inflation roughly coincided with the fading base effects of low oil prices and rising import prices.

The acceleration in US wage growth is evidence that cyclical pressure is building, as labour markets tighten and the economy nears potential. The year-on-year change in average hourly earnings bottomed at 1.5% in October 2012 and has since risen to 2.7%. Rising wages also broadened in the last two years. Unlike in the early 2000s, when workers at the top end of the wage scale experienced the strongest gains while workers with lower income experienced none, recent data shows a meaningful increase for nearly all income levels.

A strengthened global economy also is providing support, as highlighted by the International Monetary Fund, which recently reaffirmed its view that the global economy will grow more rapidly and more broadly across developed and emerging economies in 2017.

We believe we have reached an inflection point for inflation. Deflation risks have been replaced by rising inflation expectations and, based on cyclical factors alone, we believe inflation of 2.0%–2.5% is likely. Furthermore, there is structural risk from a possible backlash against globalisation, which could lead to protectionism and higher prices. In this scenario, inflation could exceed 3.0%.

Hedging against inflation

Given this risk, investors should revisit their portfolios to ensure they have assets that can protect against inflation. Inflation can corrode purchasing power even at moderate rates. A 0.25% month-on-month increase in the CPI, or about 3% annualised, compounds to around 15% loss in purchasing power over five years.

Thirty years ago, investment options were limited, mainly to gold and large cap equities, but today’s investors can hedge against inflation while also maintaining their investment plans. Because inflationary pressures are likely to be relatively moderate, investors should consider assets that also offer capital appreciation or income. Thus, investors can be ‘paid to wait’ if inflation is dormant. These include real assets – real estate, commodities and infrastructure – as well as inflation-linked bonds and equities with ‘pricing power’. Key features of these inflation-hedging assets include:

  • Real estate, which includes rental apartments, businesses, and office complexes, can offer stable cash flows because many have lease structures in place.
  • Commodities contribute to headline inflation, and have historically outperformed equities and bonds when inflation rises.
  • Infrastructure assets are positively correlated with inflation because they tend to consist of monopolies (e.g., bridges, toll roads, airports) with few alternatives for consumers, giving the ability to maintain margins by passing on price increases.
  • Inflation-linked bonds provide a real yield for investors by contractually linking inflation to principal and interest payments. When issued by government entities, they are usually seen as low-risk diversifiers.
  • Companies with pricing power enjoy sustained demand for their product or service, passing on price increases to customers without losing market share. Equities also offer exposure to growth, and may provide returns even if inflation is dormant.

Liquid versions of these assets offer the added benefit of flexibility, allowing for allocation changes in response to different manifestations of inflation. For example, real estate would benefit from rapidly rising property prices and rents. Commodities would benefit if the US dollar weakened. Infrastructure would benefit from fiscal stimulus targeting increased infrastructure spending.


Ron Temple is Managing Director and Portfolio Manager/Analyst at Lazard Asset Management. This document is for informational purposes only and does not constitute an investment agreement or investment advice. All opinions expressed herein are as of the date of this article and are subject to change.


Are we again crying wolf on inflation risk in pandemic response?

The unreliability of inflation forecasting

Deflation is good


Most viewed in recent weeks

Three steps to planning your spending in retirement

What happens when a superannuation expert sets up his own retirement portfolio using decades of knowledge? He finds he can afford much more investment risk in his portfolio than conventional thinking suggests.

Five stock recoveries not hanging on COVID predictions

The focus on predicting the recovery from the pandemic is the wrong emphasis. Better to identify great companies benefitting from market changes over a three- to five-year horizon with or without COVID.

Peak to peak, which LIC managers performed during COVID?

A comprehensive review of dozens of LICs shows how they performed in the crucial 'peak to peak' of COVID. This 14 months tested the mettle and strategies of a sector often under fire, with many strong results.

Finding sustainable dividend stocks on the ASX

There is a small universe of companies on the ASX which are reliable dividend payers over five years, are fairly valued and are classified as ‘negligible’ or ‘low’ on both ESG risk and carbon risk.

Blink and you missed a seismic shift in these stocks

Blink and it happened. If announcements in this sector were made by a producer of iron ore, gas, copper or some new tech, the news would have been splashed across the front pages. Have we witnessed a major change?

How inflation impacts different types of investments

A comprehensive study of the impact of inflation on returns from different assets over the past 120 years. The high returns in recent years are due to low inflation and falling rates but this ‘sweet spot’ is ending.

Latest Updates


Platinum’s four guiding investment principles

Buying mispriced stocks is often uncomfortable when companies are outside the spotlight and markets are driven by emotions. And it's inescapable that the price paid ultimately determines the end result.


Andrew Lockhart on corporate loans as an income alternative

Loans to corporates were the traditional domain of banks, but as investors look for income alternatives to term deposits, funds have combined hundreds of loans into a single structure to create a diversified investment.


10 things I learned in my faux-retirement

Pre-retirees should ‘trial run’ their retirements. All those things you want to do - play golf, time with the family, a hobby, write a book - might not be so appealing in reality, but you might discover other benefits.


Achieving a sufficient retirement income portfolio

Retirees require a reliable income stream to replace the wages they received when they were working and should focus on the dollar income generated over time rather than the headline yield percentage.

'Wealth of Experience' podcast and ASA webinar on ETFs v LICs

Peter reveals some top stock picks with an emphasis on long-term assets like Sydney Airport, Graham discusses spending in retirement and valuing assets, the key to Amazon, guest Andrew Lockhart and plenty more.


Lucy Turnbull’s three lessons on leadership and successful careers

From promoting women to boost culture to taking opportunities as they arise, Lucy Turnbull AO says markets should not drive decision-making and leaders must live and breathe the company's mission and values.


Are concerns about inflation inflated?

While REITs and some value stocks are considered 'inflation-sensitive' assets, the data provide little support that they are good inflation hedges, and energy stocks and commodities are too volatile. So what works?



© 2021 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.