Rob Morgan, Chief Investment Analyst at Charles Stanley, part of Raymond James Wealth Management, says that portfolio allocation may need to be more selective in a more fractured world.
In a more fractured world shaped by structurally higher energy and food inflation and constrained consumer spending power, portfolio allocation may need to be more selective, more valuation aware, and more focused on resilience.
Businesses with strong brands, essential services, or contracts that link payment increases to inflation may be better positioned than those reliant on discretionary consumer spending.
Companies with pricing power – the ability to pass higher costs on to customers – tend to be more resilient to energy shocks, especially if they have strong balance sheets and tangible assets.
Meanwhile, highly indebted or speculative businesses can struggle. It’s also a time to focus on long-term structural growth drivers that can power through despite the hurdles of inflation and weaker overall economic activity.
Some equity markets have already shrugged off recent events after an initial dip and have recovered significant ground.
That’s especially the case in the US where the S&P 500 has powered to all-time highs driven by technology stocks where investors perceive growth to be resilient.
The overall impact on US economic activity is also judged to be limited given that consumer spending is disproportionately driven by higher-income households whose spending patterns are less sensitive to energy prices.
In contrast, the geographies more vulnerable to energy fluctuations – notably Europe, Japan, and certain emerging markets such as India – have recovered more modestly.
Bond markets, too, bear the scars of recent events with prices lower and yields significantly above their pre-crisis levels.
The UK is a case in point with the 10-year gilt yield at around 4.75%, significantly above its end of February level of 4.25%.
The traditional assumption that bonds cushion equity volatility can break down when inflation is high, and investors do need to consider further dimensions of diversification in a more inflationary world.
That said, bonds still play a role, and high starting yields from this point mean in terms of a positive total return, income plus capital, they can absorb a hit from interest rate and inflation expectations ratcheting higher still.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The writer’s views are their own and do not constitute financial advice.
This information should not be relied upon by retail clients or investment professionals. Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
Main image: background, colourful, ruvim-noga-o0R4iqk1eRQ-unsplash
