What infla­tion means for various asset classes

Consu­mer prices have been on the rise for more than a year and have now reached record heights. This unusually high level of infla­tion is the result of various factors. 

Global supply chain issues, coro­na­vi­rus lock­downs and excep­tio­nally expan­sive mone­tary and fiscal policy are just some of the reasons why price rises have been so swift. Plus, energy prices have risen shar­ply due to the war in Ukraine. Lots of inves­tors are rightly asking how they can hedge against the incre­asing price pres­sure. To answer this ques­tion, we look at the most promi­nent asset clas­ses: equi­ties, bonds, gold and real estate.

Equi­ties

Histo­ri­cally, equi­ties have deve­lo­ped parti­cu­larly well in envi­ron­ments with mode­rate, stable infla­tion, since a low level of econo­mic uncer­tainty enables compa­nies’ profits to be fore­cast reason­ably well. Howe­ver, if price levels spike without warning, this can create massive distor­ti­ons on the stock markets. Sudden price rises pose a 

risk to opera­tio­nal margins as higher produc­tion costs cannot be passed on to custo­mers imme­dia­tely. Higher infla­tion levels force central banks to adopt a more rest­ric­tive mone­tary policy with higher inte­rest rates, which causes stock valua­tions to shrink due to incre­asing future divi­dend discount factors. Plus, the measu­res to combat infla­tion cloud the pros­pect of growth, incre­asing the pres­sure on equities.

Howe­ver, it is worth making a distinc­tion within the equi­ties asset class, as not all sectors are equally affec­ted by infla­tion. This is illus­tra­ted by an analy­sis of stock market returns over the last 50 years: in an envi­ron­ment marked by incre­asing, low infla­tion, compa­nies in the IT sector had the highest returns, while the defen­sive sectors of consu­mer stap­les, health­care and utili­ties under­per­for­med. During peri­ods of consis­t­ently high infla­tion, commo­di­ties and energy fared the best and finan­cial stocks the worst. Commo­dity-rela­ted sectors domi­na­ted when infla­tion rose to more than 6%, while consu­mer-rela­ted sectors and the IT sector were ones to avoid.

Bonds

Bonds with a fixed coupon and pre-defi­ned repay­ment at matu­rity (par value) are heavily sensi­tive to chan­ges in infla­tion. The fixed coupon payment reflects infla­tion expec­ta­ti­ons at the time of issue and is not amen­ded subse­quently, even if market condi­ti­ons change. If infla­tion acce­le­ra­tes, the discoun­ted future coupons and redemp­tion are worth less today, leading to a tempo­rary price loss of the bond. The longer the remai­ning term of the bond, the grea­ter this loss. Infla­tion-linked bonds, known as ILBs, offer long-term protec­tion against rising infla­tion. The nomi­nal value of an ILB is linked to reali­sed infla­tion and thus guaran­tees a real return regard­less of infla­tion. Howe­ver, ILBs are not issued in Swiss francs.

Gold

Gold has always enjoyed a repu­ta­tion as a good protec­tor of assets from currency deva­lua­tion. This is because only a limi­ted amount occurs natu­rally, it has a stable demand due to its usage in various indus­trial proces­ses, and it cannot be deva­lued as a result of mone­tary policy. But gold has not always lived up to its repu­ta­tion. An infla­tion-hedging invest­ment should keep pace with consu­mer prices. Howe­ver, in peri­ods of high infla­tion accom­pa­nied by highly rest­ric­tive mone­tary policy, gold has gene­rally gene­ra­ted a nega­tive return for investors.

The deve­lo­p­ment of real inte­rest rates, i.e. inte­rest rates minus infla­tion, is more important in the valua­tion of gold than the proper­ties mentio­ned above. Since gold does not yield an income return in the form of inte­rest payments, inves­t­ing in gold invol­ves weig­hing up the poten­tial price gains against the inte­rest earned on cash. The higher the real inte­rest yield, the less attrac­tive gold becomes. 

Real estate

Real estate offers more direct protec­tion against infla­tion. Gene­rally, commer­cial leases in Switz­er­land are linked to infla­tion. Resi­den­tial rents are usually tied to a rela­tively slug­gish refe­rence inte­rest rate and only to a lesser extent to consu­mer prices. Infla­tion and inte­rest rates can thus be passed on to rents, but only with a delay. Howe­ver, the higher discount rates have a direct impact on the valua­tion models, which is why real estate funds and compa­nies have had to record simi­larly high losses as shares this year. In the longer term, howe­ver, real estate should offer good protec­tion against inflation.

In vola­tile times, it is important to keep seve­ral opti­ons open in order to be able to react promptly. For the manage­ment of foun­da­tion assets in parti­cu­lar, a constant, proac­tive adjus­t­ment of the tacti­cal asset allo­ca­tion, taking into account the foundation’s risk capa­city and risk tole­rance, is key to ensu­ring the orga­ni­sa­tion can meet its objec­ti­ves as set out in its artic­les of association.