The risks of heightened inflation and rising bond yields may not be yet fully reflected in bond prices, making equites more attractive from an asset allocation perspective, according to the head of Nordea Asset Management’s £100bn ($141bn, €116bn) multi assets team.
As consumer prices continue to rise sharply in many parts of the world, particularly in the US, Asbjørn Trolle Hansen said inflation risk is something to consider within asset allocation.
“Economies have rebounded from their Covid-induced economic problems and some areas have jumped straight into inflationary concerns,” he said. “The real question is whether companies are price takers or whether they can drive through price increases to reflect their rising costs. At this point many companies can push price increases.”
While US CPI has reached 5% – the biggest year-on-year increase since August 2008 – Trolle Hansen said that longer-term inflation expectations remain at about 2.5%. This, he argued, implies the market currently expects inflation to be manageable.
Equities
In this environment, the Nordea multi asset team is using equities for its “inflation play”.
“Inflation is typically reflected in rising bond yields, but only partially,” Trolle Hansen said. “We feel that the risks of rising inflation – and rising bond yields – may not yet be fully reflected in bond prices.”
On the flip side, Trolle Hansen said equities typically do well in an inflationary environment, since nominal earnings growth usually accelerates with inflation.
“A year ago, market expectations for 2021 earnings growth was sub 2%,” he said. “The higher expectations we are seeing now reflects the success of the stimulus packages.”
‘Pass through price increases’
As far as the growth versus value outlook goes, Trolle Hansen said even though inflation is beneficial for the earnings growth of both types of stocks, value stocks tend to perform better first. Furthermore, he said value stocks have a lot of potential for price recovery.
“We certainly always favour companies with strong business models that can include price stability, and in this case, the possibility to pass through price increases,” he said. “Overall, we are seeing greater ability to pass through rising costs than we have seen for the last 20 years.”
John Husselbee, head of the Liontrust multi-asset team, said rising inflation has remained a key focus throughout recent months. He noted there was clearly some tech-centred selling in May as a result, with investors continuing to exit longer duration growth companies and adding fuel to the ongoing value rotation.
“Both the Federal Reserve and Bank of England are clearly willing to tolerate a cost-push spike in inflation as the global economy recovers but, while bond markets seem to have settled after recent selloffs, there are lingering concerns this could give way to more enduring demand-pull wage inflation last seen in the 1980s,” Husselbee said.
“We are confident inflation will drop away in the medium term and conditions are not forming, for now, that pave the way toward more persistent rises,” he added. “Wage inflation remains one of the most significant factors in the overall picture but technology and globalisation have provided a deflationary offset in recent years and we do not believe this is about to change. “
