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.
Transcript
Hi, I’m Michelle Butler, Senior Portfolio Specialist at Cohen & Steers.
Recent data showing inflation slowing has been encouraging, and we believe that trend will continue in 2024. However, inflationary risks remain abound, and we believe secular forces will likely result in inflation remaining elevated over the coming decade—certainly higher on average than what we were accustomed to in the preceding 10-year disinflationary regime. In this new “stagflationary” regime, the potential for periodic, unexpected inflationary bouts remains a real risk.
Let’s briefly look at some of the factors behind this assessment.
One: Commodity underinvestment. Because commodity prices are primarily influenced by supply/demand forces, there is a saying that “low prices solve low prices” and “high prices solve high prices.” The pullback in commodities in the mid-2010s, due to persistent oversupply at the time, forced capital discipline on commodity producers, which reigned in supply. Today, energy and mining companies are focused on strengthening their balance sheets and creating shareholder value through a more restrained supply growth mentality. Consequently, inventories for many commodities sit near 10-year lows.
Current supply/demand imbalances are supportive of commodity prices. Additionally, production costs often rise as a consequence of higher interest rates, which may further exacerbate inflationary pressures.
Two: Tight labor markets. Labor undersupply, driven by a reduction of available, qualified workers, has given employees greater bargaining power, which has increased wage pressures. Wage inflation is notoriously “sticky” and may reinforce demand-pull inflationary forces that remain broadly present in the market today.
Three: Geopolitics & deglobalization. As we’ve seen with the Russia–Ukraine war, geopolitical tensions, economic sanctions and disrupted supply chains can lead to inflationary price spikes of key raw materials if taken offline, and may lead to increased deglobalization or “friend-shoring,” which essentially means countries trading with those that adhere to similar business practices and values.
Friend-shoring encourages trade partner selectivity over potentially trading with the lowest-cost producer, which inherently limits the supply of low-cost goods, services, and labor. Again, increasing the risk of inflation.
Four: Fiscal uncertainty. In the wake of both the global financial crisis and the Covid pandemic, fiscal obligations have reached near-historic levels across most major economies. Political pressure to further stimulate against the backdrop of already burdensome debts creates incentives for policymakers to inflate away debt obligations, driving up investor skepticism and, potentially, interest rates, resulting in higher interest expense, policy uncertainty and spending levels and, consequently, persistent inflationary expectations.
There’s an addage that history doesn’t repeat, but it often does rhymes. We believe there are two modern analogs to today’s inflationary environment, namely, the World War Two era and its aftermath, and the infamous ‘1970s-inflation era.
As you can see, in both prior inflationary regimes, after inflation was initially contained, and, we are currently still in the containment zone now (represented by the dotted green line). Interestingly there was a resurgence in inflation in the months and years following, showing the difficulty for policymakers to control inflation when the starting point is as high as it has been and when inflation is supply-driven and embedded in market dynamics.
It’s not our base case that inflation is going to revert back up to 9%, but at the same time, when you look back and learn from history, we also can’t rule that out. We certainly believe that despite inflation trending lower, on average over the next decade, we will be living with higher inflation than we have been accustomed to. And that’s why maintaining an allocation to real assets is so important from a strategic perspective.
Timing the market, and especially inflation (which loves to surprise) with precision is likely a losing strategy.
We have long advocated that investors maintain a strategic allocation to real assets given the portfolio diversification, total return and inflation sensitivity benefits. For all three of those key features, the asset class appears particularly well-positioned for the coming years.
ABOUT THE AUTHORS
Michelle Butler, Senior Vice President, is a Real Assets Portfolio Specialist for Cohen & Steers, specializing in Global Listed Infrastructure, Midstream Energy, and Commodities.
FURTHER READING
Maintaining a strategic allocation to real assets
Senior Portfolio Specialist Michelle Butler spoke with Portfolio Adviser for a video interview about how a diversified real assets allocation may benefit investors in the new macroeconomic regime characterized by higher interest rates and inflation compared to the previous decade.
3 Reasons to own real assets today
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.
Capital Market Assumptions: Expectations for the next 10 years amid a generational change for markets
We expect higher fixed income and real asset returns alongside lower U.S. equity returns for the next decade.
Data quoted represents past performance, which is no guarantee of future results. The views and opinions presented in this document are as of the date of publication and are subject to change. There is no guarantee that any market forecast set forth in this document will be realized. This material represents an assessment of the market environment at a specific point in time and should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict the performance of any investment.
This material is not being provided in a fiduciary capacity and is not intended to recommend any investment policy or investment strategy or to account for the specific objectives or circumstances of any investor. 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. Cohen & Steers does not provide investment, tax or legal advice. Please consult with your investment, tax or legal professional regarding your individual circumstances prior to investing.
Important Risk Considerations: Investing involves risk, including the entire loss of capital invested. There can be no assurance that the investment strategy will meet its investment objectives. Diversification is not guaranteed to ensure a profit or protect against loss. 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. Risks of investing in REITs are similar to those associated with direct investments in real estate securities, including (i) 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. 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, including market risk, credit risk, counterparty risk, leverage risk and liquidity risk and 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. Securities of natural resource companies may be affected by 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.
Futures Trading Is Volatile, Highly Leveraged and May Be Illiquid. Investments in commodity futures contracts and options on commodity futures contracts have a high degree of price variability and are subject to rapid and substantial price changes. Such investments could incur significant losses. The use of options on commodity futures contracts is to enhance risk-adjusted total returns. The use of options, however, may not provide any, or only partial, protection for market declines. The return performance of the commodity futures contracts may not parallel the performance of the commodities or indexes that serve as the basis for the options it buys or sells; this basis risk may reduce overall returns.
Cohen & Steers Capital Management, Inc. (Cohen & Steers) is a U.S. registered investment advisory firm that provides investment management services to corporate retirement, public and union retirement plans, U.S. endowments, foundations and mutual funds. Cohen & Steers UK Limited is authorized and regulated by the Financial Conduct Authority (FRN458459). Cohen & Steers Asia Limited is authorized and regulated by the Securities and Futures Commission of Hong Kong (ALZ367). Cohen & Steers Japan Limited is a registered financial instruments operator (investment advisory and agency business and discretionary investment management business with the Financial Services Agency of Japan and the Kanto Local Finance Bureau No. 3157) and is a member of the Japan Investment Advisers Association. Cohen & Steers Ireland Limited is regulated by the Central Bank of Ireland (No.C188319). Cohen & Steers Singapore Private Limited is a private company limited by shares in the Republic of Singapore.
For Investors in the Middle East: This document is for information purposes only. It does not constitute or form part of any marketing initiative, any offer to issue or sell, or any solicitation of any offer to subscribe or purchase any products, strategies or other services, nor shall it or the fact of its distribution form the basis of, or be relied on in connection with, any contract resulting therefrom. In the event that the recipient of this document wishes to receive further information with regard to any products, strategies, or other services, it shall specifically request the same in writing from us.