Roelof Feenstra, Portfolio Manager at Independent Securities
High inflation, geopolitics, the Russian-Ukraine war and a looming recession sent equity market indices tumbling into a bear market territory during the first six months of 2022, prompting investors to seek safe havens and find tactical investment opportunities to take advantage of current market conditions.
“With the possibility of the US entering a recession caused by aggressive monetary tightening and a stagflationary environment (the combination of high-interest rates coupled with low economic growth is known as stagflation), investors concerned about the potential impact on their portfolios could consider tactical investments in sectors that could protect during such periods. Although recessions are generally negative for equities, high-interest environments do benefit certain sectors such as industrial commodities, gold and real estate.”
Alternatively, investors with a longer-term strategy could use such an environment to acquire shares in quality companies trading at significant discounts with the potential to recover strongly once economic growth returns says Roelof Feenstra, portfolio manager at Independent Securities.
The macro-economic environment backdrop remains in the balance and provides safe havens in real estate, gold, commodities and value shares in certain growth sectors
“We believe that the spike in inflation in the US has already happened and although inflation could remain relatively high over the short- to medium term, there are signs that the rate of change is moderating,” says Feenstra.
While it looks possible that the US may enter a recession during the second half of this year, he stresses that, as with all things in global markets, it is challenging to predict these events with any certainty. What is clear is that the US will experience a reduction in economic growth caused by the aggressive monetary tightening of the US Federal Reserve (Fed). It also seems at this stage that the Fed is desperately trying to catch up with inflation, risk overshooting with their response, and risk increasing rates too aggressively which could push the US economy into a recession.
So, what does this mean for investment portfolios?
Global inflation has been spurred by the extreme stimulus measures implemented by governments and central banks during the Covid pandemic. The resultant surge in demand was met by supply-side constraints as lockdowns severely disrupted global supply chains. Adding to inflationary pressures is Russia’s invasion of Ukraine and the subsequent sanctions imposed on Russia have led to an acute global shortage in the supply of key commodities. As a result, global oil, gas and metal prices have increased significantly. Ukraine is also one of the major producers of wheat and suppliers of fertilizer to the world, and the subsequent loss of this supply of these key commodities has also contributed to the current high levels of inflation, resulting in a significant supply-demand mismatch for commodities in the market.
“During stagflation, investors can expect certain sectors such as industrial commodities, gold and real estate to offer some level of protection,” says Feenstra.
Gold is generally seen as a safe haven for investors during turbulent times and tends to perform well during stagflationary periods, according to Feenstra. He notes that real estate has also historically done well during such periods as the effects of inflation get passed through to rental escalations and mortgage rates are typically fixed while the replacement value of assets also rises. Industrial commodities are materials used to produce goods and is also a key component of inflation baskets. During periods of high inflation such inputs costs are rising and investors exposed to companies producing such commodities can expect good returns.
Feenstra stresses that these tactics should be viewed as temporary and portfolios should be readjusted once inflation and economic growth normalise.
How to invest in tactical asset classes during periods of stagflation:
Given that energy and food prices are currently the biggest drivers of the high levels of inflation globally, it makes sense to strategically invest directly into these assets. You can do so by, for instance, investing in the iShares MSCI Global Agriculture Producers ETF, which has generated a return of 21% over one year, and in the iShares MSCI Global Energy Producers ETF, which has returned a substantial 49% over a year.
Other options that have historically provided protection during stagflation include inflation-linked government bonds and gold. The iShares TIPS Bond ETF (up 4% over a year) and iShares Gold Trust ETF (up 14.5% over a year) can be expected to perform better than other asset classes.
“Rather view these historically elevated levels of inflation as an opportunity to pick up assets trading at depressed levels and likely to recover strongly once inflation and economic growth return to normal levels,” notes Feenstra.
“Periods such as these in the financial markets are great for active managers as there are pockets of value emerging that offer attractive opportunities. A mild recession is already priced in, and the risk-reward setup is sufficiently favourable to start adding quality stocks to portfolios. As always, however, it is important to speak to your financial adviser before enacting any major changes in portfolios,” concludes Feenstra.
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