Insights on Income

Rising Inflation: A Challenge and an Opportunity for Multi-Asset Investors

One of the most fundamental needs for many investors, particularly retirees, is generating enough cash flow from their investment portfolios to meet their spending needs. Given the extraordinary monetary policy response to the COVID-19 crisis, this objective has become exponentially more difficult to achieve. A defining feature of the current market environment is the scarcity of yield globally, with over $10T of negative yielding fixed income securities. To complicate matters, these incredibly low yields come at a time of resurgent inflation, making the prospect of generating a positive real yield from high quality bonds nearly impossible.

Positive Inflation-Adjusted Yields Are Scarce

Yield minus U.S. 5-year expected inflation

Positive inflation

Index performance does not represent actual Fund performance. For actual fund performance, please visit www.iShares.com or www.blackrock.com. Source: Bloomberg, Barclays and JP Morgan, September 2021. Yield represented by yield to worst for fixed income and 12-month yield for equities. Inflation represented by the U.S. 5-year breakeven inflation rate. Breakeven rates are calculated by subtracting the real yield of the inflation linked maturity curve from the yield of the closest nominal Treasury maturity. The result is the implied inflation rate for the term of the stated maturity. Euro Inv Grade represented by the Bloomberg Euro-Aggregate Corporates Index. US Agency represented by the Bloomberg US Agg Agency Index. US Treasury represented by the Bloomberg US Treasury Index. CMBS represented by the Bloomberg US Agg CMBS Index. US Agg represented by the Bloomberg US Aggregate Index. US MBS presented by the Bloomberg US MBS Index. US Inv Grade represented by the Bloomberg US Investment Grade Index. Asia Inv Grade represented by the JP Morgan JACI Investment Grade Index. European High Yield represnted by the Bloomberg Pan-European High Yield Index. MSCI High Dividend represented by the MSCI World High Dividend Yield Index. EM Debt represented by the JPM EMBI Global Total Return Index. US High Yield represented by the Bloomberg US Corporate High Yield Bond Index. US High Dividend Stocks represented by the S&P 500 High Dividend Index. Bank loans represented by the S&P Leveraged Loan Index.

For much of the past year, policymakers and investment pundits have considered this surge in inflation to be transitory. While the initial summer inflation spike was largely driven by more volatile CPI components related to re-opening activity (e.g. airfares, lodging away from home) and COVID-19-related supply chain bottlenecks (e.g. semiconductor shortages impacting used car prices), many of those factors have waned. Today, a pick-up in more stable inflationary components, like home prices, are now taking the wheel.

Stable components: main driver of recent inflation

Stable examples: new vehicles, rent
Volatile examples: lodging away form home, used vehicles

Recent inflation

Source: BlackRock as of November 2021. Bars show the deviation from 3-year Core CPI trend broken out by stable and volatile components.

Because of the increase in these stickier measures of inflation, we believe inflation will remain above the Fed’s target range and above the trend level we observed in the expansionary decade following the global financial crisis. Higher, more persistent inflation has in turn pulled forward expectations for U.S. rate hikes and guided the Fed’s commitment to taper their bond buying program. We’ve also seen similar trends abroad with central bankers in Australia, the UK and other developed markets taking a moderately more hawkish stance of late to stave off potential inflation overshoots.

The good news is that for flexible, multi-asset investors, opportunities do exist to overcome negative real yields and inflation.

As observed in the first chart, higher income-generative assets like dividend stocks, high yield bonds, emerging market bonds and bank loans have offered positive real yields even after the recent inflation spike. And they may offer less rate sensitivity as well, particularly in the case of floating rate bank loans, whose interest rates adjust to reflect changes in short-term interest rates.

When it comes to opportunities to combat inflation more directly, an area we currently favor is U.S. Real Estate Investment Trusts (“REITs”). REITs tend to offer resilient fundamentals in inflationary environments through real estate price appreciation and rental growth. REITs may also benefit as employees re-populate offices and broader activity normalizes. Additionally, with the recent move up in Treasury yields, we are less concerned about imbedded interest rate risk in REITs. Finally, we believe this sector is less exposed to supply chain issues which we expect will continue to negatively impact certain companies well into 2022.

Importantly, while we think inflationary pressures will remain firm for the foreseeable future (supported by another strong CPI print released on November 10th, 2021), we do not believe we will see runaway inflation. Ultimately, longer-term secular trends like technology advancement and aging demographics work against higher inflation and very much remain in place today, even if the intermediate-term direction for inflation remains elevated. Concerns about stagflation and comparisons to the high inflationary regime of the 1970’s are also a bit premature, as growth remains robust and price increases have largely been driven by strong demand amidst a global economy still recovering from a pandemic.

Bottom line - taking a higher income, multi-asset portfolio approach can help overcome the challenges associated with rising inflation while uncovering unique opportunities for diversification and upside potential.

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Michael Fredericks
Head of Income Investing for BlackRock Multi-Asset Strategies Team
Michael Fredericks, Managing Director, is head of Income Investing for the BlackRock Multi-Asset Strategies & Solutions group and lead portfolio manager for the ...
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Justin Christofel, CFA
Portfolio Manager, Multi-Asset Portfolio Strategies
Justin Christofel, CFA, CAIA, Managing Director and portfolio manager, is a member of the BlackRock Multi-Asset Strategies & Solutions group, which is responsible for ...
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