Inflation is easing but expected to remain above trend

After the challenging inflation and interest rate shocks in 2022, the global economy is in transition. Inflation, which peaked last fall, is expected to decline further. But a rapid return to pre-pandemic conditions of sub-2% annual price increases appears doubtful. Inflation will likely remain sticky and, in the U.S., may not return to the Federal Reserve’s implied 2% target before the end of 2024 due to wage pressures, higher costs from deglobalization and other factors. In the meantime, the inflation protection mechanisms in infrastructure pricing structures should remain supportive of the asset class.

Historically, listed infrastructure has produced above-average returns when inflation is elevated but falling, similar to today (Exhibit 1). Since 1973, the asset class has produced a 9.9% average 1-year real return when inflation has been above trend but moderating. That’s an annual real return 2.3 percentage points above its long-term average of 7.6% across the entire 50-year study period.

Keep in mind that economists have consistently underestimated inflation during the last two years. Previous periods of unexpected inflation similar to what the world has recently endured (such as post-WWII and the 1970s) saw a considerable volatility in inflation following its initial containment. We believe those historical periods correlate with the environment we are moving towards, suggesting the potential for future challenges in predicting inflation. And it accentuates the value of an infrastructure allocation as a portfolio inflation hedge.

EXHIBIT 1

Infrastructure has produced above-average returns when inflation was high but moderating

Infrastructure average 1-year real return (Jan. 1973–Mar. 2023)

At March 31, 2023. Source: Refinitiv Datastream, Cohen & Steers analysis.
Data quoted represents past performance, which is no guarantee of future results. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. There is no guarantee that any market forecast set forth in this presentation will be realized. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend might begin. See end notes for additional disclosures.

Today’s macro environment suggests the appetite for infrastructure’s attributes will remain high

A spirited debate is being waged these days about the economy’s direction. A recession is possible in 2023 as the effects of credit tightening and the recent banking crisis work through the system. And the risk to growth appears to be to the downside.

Central banks are in the difficult position of balancing still-high inflation alongside financial sector instability. Backing off from further tightening to allow financial markets to stabilize may further exacerbate inflationary pressures. On the other hand, continuing to hike rates to curb inflation may further inflame financial market stress, particularly since the root cause of the recent banking crisis stems from a deeply inverted yield curve. Complicating the situation, banks are tightening lending standards, which typically leads to a slowdown in growth (particularly in the most rate-sensitive areas of the economy, such as equipment and construction) and a reduction in hiring.

EXHIBIT 2

Infrastructure’s predictable cash flows are a function of price and volume

Revenue drivers of infrastructure subsectors

At March 31, 2023. Source: Cohen & Steers.
This chart is for illustrative purposes only and does not reflect information about any fund or other account managed or serviced by Cohen & Steers. There is no guarantee that any historical trend referenced above will be repeated in the future, and there is no way to predict precisely when such a trend will begin. There is no guarantee that any market forecast set forth in this presentation will be realized. See end notes for additional disclosures.

Regardless of the potential depth and length of the recession, we expect investor demand for infrastructure to remain high. This is partly because the asset class generally has lower volatility relative to the broader stock market due to its defensive traits, such as inelastic demand for infrastructure services and companies’ fairly stable cash flows (Exhibit 2).

Challenges may prevent a rapid rebound in traditional risk assets

Infrastructure has historically outperformed the broad global equity market in three of four phases of the business cycle (Exhibit 3). Our study is conditioned on recessions as reported by the National Bureau of Economic Research (NBER) and expansion subdivisions based on the Conference Board’s Composite Index of Coincident Indicators. Infrastructure has outperformed the broader equity market in periods characterized by overheating economic conditions (late cycle), business cycle downturns (recession) and the recoveries that follow (early cycle).

While the NBER did not declare a recession in 2022, the year saw several hallmarks of one, including two consecutive quarters of negative growth, a steep yield curve inversion and a pronounced drawdown in equity prices. The banking crisis may intensify the severity of the current recessionary period.

We believe challenges in the new economic paradigm—including persistent higher inflation and higher nominal interest rates—may prevent the rapid acceleration in economic activity usually seen in the early cycle recovery stage. For instance, with little slack currently in the system, a sharp rebound in corporate profits appears unlikely.

Consequently, a typical V-shaped rebound in traditional risk assets may not occur either. Equity valuations in most markets appear only fair, not cheap, and higher structural inflation alongside greater volatility suggests that risk premia will remain elevated, which may limit equities’ price gains. Such conditions set the stage for infrastructure to potentially outperform the broad equity market, as investors favor these businesses for their stable cash flows and attractive income generation capacity.

EXHIBIT 3

Listed infrastructure historically has outperformed in 3 of 4 business cycle phases

Returns vs. global equities (%)

1973–2022

At December 31, 2022. Source: Cohen & Steers.
Past performance is no guarantee of future results. An investor cannot invest directly in an index, and index performance does not reflect the deduction of any fees, expenses or taxes. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. Returns based on the annualized arithmetic mean of monthly returns. U.S. recessions are determined by the NBER (82 of 600 months). Expansion periods subdivided by Cohen & Steers based on major trends in the Conference Board’s Composite Index of Coincident Indicators (CBCI): early cycle (accelerating CBCI; 173 months), mid-cycle (stable CBCI; 225 months) and late cycle (decelerating CBCI; 120 months). Infrastructure returns are based on a composite of sectors in the Refinitiv Worldstream Index series that Cohen & Steers believes are largely representative of today’s global listed infrastructure universe, allowing for a longer-term, multi-cycle analysis than what is available with modern listed infrastructure indexes. The composite had a 0.95 correlation to the FTSE Global Core Infrastructure 50/50 Index since the FTSE index’s inception in 2009. Global equities based on the Refinitiv Worldstream Global Equity Index. See end notes for index associations, definitions and additional disclosures.