The Russia-Ukraine conflict has put additional upward pressure on inflation, increasing the likelihood that economic growth will slow and that stagflation— historically a strong environment for real assets—may emerge.
KEY TAKEAWAYS
- The commodity supply shock resulting from the war has driven inflation higher, increasing the chances that global growth will slow.
- The conflict has impacted commodity markets and may have implications for other real assets categories, particularly global real estate.
- Slower growth and higher inflation raise the prospect of stagflation, which historically has been a strong environment for real assets.
The commodity supply shock has driven inflation higher
The notion that the pronounced upswing in inflation in recent months would be transitory has fallen by the wayside with Russia’s invasion of Ukraine.
Global headline consumer inflation prior to the war was at 7.2% year-over-year, up from less than 2% during the Covid recession and roughly 2% over the last cycle (Exhibit 1). Supply disruptions stemming from the conflict have placed additional upside pressure on commodity prices, which were already at multi- decade highs due to reopening demand and supply chain issues. Coupled with wages increasing faster than productivity and housing costs outpacing the broader cost of living, this environment has provided conditions for sustained inflation above the last cycle’s trend.
The inflation backdrop and the specter of slowing growth have made navigating near-term monetary policy increasingly challenging for central banks. Typically, slower growth would keep central banks from raising interest rates. But the market has been surprisingly willing to price in an aggressive path of expected rate hikes at a time when geopolitical risk is high and growth is expected to slow sharply from the 7% GDP registered in the U.S. in the fourth quarter.
EXHIBIT 1
Global inflation on the rise
OECD consumer prices (yr/yr % change)
At March 18, 2022. Source: Refinitiv Datastream, Cohen & Steers.
Past performance is no guarantee of future results. 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. Core inflation is a measure of inflation that excludes certain items that face volatile price movements because in finding out the legitimate long run inflation, short-term price volatility and transitory changes in price must be removed. Core inflation is most often calculated using the consumer price index (CPI), which eliminates products—usually those in the energy and food sectors—that can have temporary price shocks because these shocks can diverge from the overall trend of inflation and give a false measure of inflation. Headline inflation reflects the long-term trend in a particular price level, but does not exclude any items that face volatile price movements. See end notes for additional disclosures.
Indeed, the Federal Reserve raised its benchmark interest rate by 25 basis points on March 16 and indicated it would likely raise it six more times this year. On March 17, the Bank of England raised rates for the second time this year, and indicated five more hikes. The European Central Bank is likely to follow suit, although at a somewhat slower pace than the U.S. and U.K., given Europe’s exposure to the crisis.
The impact of the conflict may spread beyond commodities
The commodity supply shock from Russia’s invasion of Ukraine has raised concerns over the pace of global growth in 2022. Continental Europe is particularly exposed, as those countries are more reliant than the U.S. or the U.K. on Russia-Ukraine commodities.
Economic sanctions imposed on Russia have isolated the country to some extent, but they may also lead to energy supply disruptions or other supply chain constraints. The conflict has near- and long-term implications for the global economy and may ripple across real assets categories other than commodities, such as real estate.
For example, over the near term, consumers might spend less disposable income because of higher costs, potentially impacting the retail sector. Further deglobalization and investments toward lower energy dependency could lead to structurally higher inflation. Longer term, migration trends could result in incremental housing demand in certain markets (Exhibit 2).
EXHIBIT 2
Potential impact of Russia-Ukraine conflict on economies, real estate
At March 18, 2022. Source: Cohen & Steers analysis.
The views and opinions are as of the date of publication and are subject to change without notice. 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 will begin. There is no guarantee that any market forecast set forth in this presentation will be realized. See end notes for additional disclosures.
Slower growth + higher inflation = stagflation
Slackening economic growth combined with persistent, elevated inflation has raised the chances that stagflation could emerge. We define stagflation as slower GDP growth and higher inflation rates vs. the 12-months-prior consensus expectations.
While growth in major developed market economies has not declined, estimates are coming down as the impact of the Russia-Ukraine conflict becomes clearer. Forecasts for above-trend growth this year have morphed into calls for a “soft landing.” For listed real estate investors, we believe reflation or stagflation should not be cause for concern, as real estate has historically outperformed stocks and bonds in both environments.
Although real estate has underperformed its historical average real return in periods of stagflation by –1.1% since 1991, the category has nevertheless produced an average annualized real return of 6.9%. In contrast, over that same timeframe, the broad global equity market has trailed its long-term inflation-adjusted average by –5.4% under stagflationary conditions, with a modest average annual real return of 1.7%. Other real assets categories have historically performed significantly better in stagflationary periods, in both realized and relative terms (Exhibit 3).
EXHIBIT 3
Real assets historically perform well in a stagflationary environment
Relative real return by category vs. long-term average (1978–2021)
At December 31, 2021. Source: Cohen & Steers proprietary analysis, Survey of Professional Forecasters, University of Michigan Survey of Consumers.
Past performance is no guarantee of future results. The real assets blend is not representative of an actual portfolio and is for illustrative purposes only. Real estate returns prior to March 2005, commodity returns prior to August 1998, infrastructure returns prior to August 2008 and resource equities returns prior to June 2008 are hypothetical back-tested, not actual performance. Returns represent annualized average, categorized according to whether U.S. gross domestic product and the U.S. Consumer Price Index were above or below their prior-year estimates, based on the Philadelphia Federal Reserve Survey of Professional Forecasters 4-quarter-ahead real GDP forecast and the University of Michigan survey of 1-year-ahead inflation expectations, respectively. Percent of periods represented in each regime: Recovery: 24%, Reflation: 25%, Stagflation: 16%, Stagnation: 35%. 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. See end notes for index associations, definitions and additional disclosures.
Implications for real assets and alternative income
FURTHER READING
3 Reasons to own real assets
A diversified blend of real assets can potentially play a vital role in the new regime of higher inflation, higher rates and increased market volatility.
Secular drivers of inflation
Recent data indicates a slowing inflation trend, yet risks persist. Secular forces suggest that a prolonged elevated inflation period is underway with the potential for periodic price spikes. Factors driving long-term inflation include commodity underinvestment, tight labor markets, geopolitics, deglobalization and fiscal uncertainty. We see parallels to past inflationary eras, which highlight the difficulty of controlling inflation. While not predicting a return to 9%, the expectation is for a decade of higher-than-accustomed inflation, underscoring the importance of having a real assets allocation.
Opportunities in the era of scarcity
The world is transitioning from an era of commodity abundance to one of undersupply. We believe this shift may result in significant returns for commodities and resource producers over the next decade.
Index definitions / Important disclosures
An investor cannot invest directly in an index and index performance does not reflect the deduction of any fees, expenses or taxes. Index comparisons have limitations as volatility and other characteristics may differ from a particular investment.
No representation or warranty is made as to the efficacy of any strategy or fund or the actual returns that may be achieved.
Real assets blend: 27.5% real estate, 27.5% commodities, 15% infrastructure, 15% resource equities, 10% short-duration fixed income and 5% gold. Real estate: Datastream Developed Real Estate Index through 2/28/05; FTSE EPRA/NAREIT Developed Index thereafter. The Datastream Developed Real Estate Index encompasses listed real estate companies in developed markets and is compiled by Refinitiv Datastream. The FTSE EPRA Nareit Developed Index is an unmanaged market-weighted total return index, which consists of many companies from developed markets that derive more than half of their revenue from property-related activities. Commodities: S&P GSCI Index through 7/31/98; the Bloomberg Commodity Total Return Index thereafter. The S&P GSCI Index is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The Bloomberg Commodity Total Return Index is a broadly diversified index that tracks the commodity markets through exchange-traded futures on physical commodities, which are weighted to account for economic significance and market liquidity. Infrastructure: 50/30/20 blend of Datastream World Gas, Water & Multi-Utilities, Datastream World Pipelines and Datastream World Railroads through 7/31/08; Dow Jones Brookfield Global Infrastructure Index thereafter. The Datastream World Index Series encompasses global indexes of companies in their respective sectors (World Gas, Water & Multi-Utilities; Materials; Oil & Gas; and Pipelines) and is compiled by Refinitiv Datastream. The Dow Jones Brookfield Global Infrastructure Index is a float-adjusted market-capitalization-weighted index that measures performance of globally domiciled companies that derive more than 70% of their cash flows from infrastructure lines of business. Resource equities: 50/50 Blend of Datastream World Oil & Gas and Datastream World Basic Materials through 5/31/08; S&P Global Natural Resources Index thereafter. The Datastream World Index Series encompasses global indexes of companies in their respective sectors (Datastream World Oil & Gas and Datastream World Basic Materials) compiled by Refinitiv Datastream. The S&P Global Natural Resources Index includes 90 of the largest publicly traded companies in natural resources and commodities businesses that meet specific investability requirements, offering investors diversified, liquid and investable equity exposure across three primary commodity-related sectors: Agribusiness, Energy and Metals & Mining. Short-duration fixed income: The ICE BofA 1–3 Year U.S. Corporate Index tracks the performance of USD-denominated investment-grade rated corporate debt publicly issued in the U.S. domestic market with a remaining term to maturity of less than 3 years. Gold: Gold spot price in USD per Troy ounce. Global stocks: MSCI World Index, a market-capitalization-weighted index consisting of a wide selection of stocks traded in 24 developed markets. U.S. Treasury bonds: The ICE BofA U.S. Treasury 7-10 Year Bond Index measures the performance of public obligations of the U.S. Treasury that have a remaining maturity of greater than 7 years and less than or equal to 10 years.
Data quoted represents past performance, which is no guarantee of future results. The views and opinions are as of the date hereof, subject to change without notice and represents an assessment of the market environment at a specific point in time, should not be relied upon as legal, investment or tax advice and is not intended to predict or depict performance of any investment. We consider the information to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of appropriateness for investment. Investors should consult their own financial professionals with respect to their individual circumstances. 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 will begin. There is no guarantee that a market forecast made in this commentary will be realized. The mention of specific securities is not a recommendation or solicitation to buy, sell or hold any particular security and should not be relied upon as investment advice.
Not an inducement to buy or sell commodity interests.
Real assets risks. A real assets strategy is subject to the risk that its asset allocations may not achieve the desired risk-return characteristic, underperform other similar investment strategies or cause an investor to lose money. The risks of investing in REITs are similar to those associated with direct investments in real estate securities. Property values may fall due to increasing vacancies, declining rents resulting from economic, legal, tax, political or technological developments, lack of liquidity, limited diversification and sensitivity to certain economic factors such as interest rate changes and market recessions. An investment in commodity-linked derivative instruments may be subject to greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. The use of derivatives presents risks different from, and possibly greater than, the risks associated with investing directly in traditional securities. Among the risks presented are market risk, credit risk, counterparty risk, leverage risk and liquidity risk. The use of derivatives can lead to losses because of adverse movements in the price or value of the underlying asset, index or rate, which may be magnified by certain features of the derivatives. The market value of securities of natural resource companies may be affected by numerous factors, including events occurring in nature, inflationary pressures and international politics. Global infrastructure securities may be subject to regulation by various governmental authorities, such as rates charged to customers, operational or other mishaps, tariffs and changes in tax laws, regulatory policies and accounting standards. Foreign securities involve special risks, including currency fluctuation and lower liquidity. Because the strategy invests significantly in natural resource companies, there is the risk that the strategy will perform poorly during a downturn in the natural resource sector.
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