Avoid Bonds as Inflation Rises, These Strategists Say. Look at Energy and Emerging Markets Instead.
Even if inflation doesn’t return to 1970s levels, bonds are likely to be terrible investments for buy-and-hold investors, Gavekal strategists told clients on Thursday. Instead, they favor allocations to energy, emerging market equities and cyclical stocks to balance portfolios.
As many investors face a backdrop of inflation for the first time in their careers, portfolios may need some tweaking. “Higher inflation can be socially destabilizing,” Gavekal Research Co-Founder and Chief Executive Officer Louis-Vincent Gave, said, noting the 2018 “Yellow Jacket” protests in France when the government tried to raise gas prices to fund its energy transition, as well as the Arab Uprising in the wake of rising food prices in 2011.
It could also be destabilizing for portfolios. For decades, U.S. Treasuries have been like the Michael Jordan or Wayne Gretzky of portfolios, all-stars that have generated standout performance in times of crisis. But bond returns over the past 18 months haven’t been that good. “Michael Jordan and Wayne Gretzky have lost a step,” Gave said in the briefing. “Bonds will deliver negative returns and are going to be a terrible investment.”
They are especially bad buy-and-hold investments, added Gavekal co-founder and chairman Anatole Kaletsky, who expects slower economic growth and higher inflation—albeit not 1970s-like inflation. “Bond investors will lose money in nominal terms and lose their shirts in real terms over 10 years, but that doesn’t mean the bond market bubble is going to burst,” Kaletsky says. “Central bankers around the world have an overwhelming incentive to make sure it deflates very slowly, like a leaking tire, not a bursting balloon.”
So what should investors own instead? Gave favors energy over other commodities as a counterweight to growth stocks, with the caveat that it can create a more volatile overall portfolio. China’s efforts to deal with pollution and climate change is leading to rationing of factory production—none of which is good for steel or petrochemicals, he says.
The country’s broader energy transition could mean China decides to get out the business of producing aluminum, steel and petrochemicals, considering it often has to import the inputs to then export the final products, Gave says. Russia could pick up the steel production, tapping into its cheap electricity and iron/ore and coal—a reason Gave is also bullish on Russia as well as other emerging markets linked with commodities.
Kaletsky thinks global economic growth projections, with the International Monetary Fund forecasting 4.9% growth, are too rosy. Slowing global growth could mean that growth stocks do well, a reason Kaletsky favors a barbell portfolio with commodities and more cyclical stocks—and some cash—acting as a hedge to technology and other growth stocks.
Write to Reshma Kapadia at [email protected]
