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Inevitable Global Inflation: How to mitigate the impact to your portfolio

Inevitable Global Inflation: How to mitigate the impact to your portfolio

Key Takeaways:

Source: U.S. Bureau of Labor StatisticsYoY CPI increased sharply, especially across the energy and commodities sectors.Since the Covid-19 vaccine discovery last fall, economists, governments, investors and central banks have been anticipating a global economic recovery in 2021. The accelerating pace of the vaccine rollout in the US, UK and the rest of the world, accompanied by Biden's trillions of dollars worth of economic plans, have significantly raised the inflation expectation. These factors have contributed towards a rapid recovery in the demand for goods and services around the world, especially as lockdowns are progressively lifted across key developed and emerging economies. By March 2021, the CPI for all items has increased by 4.2% on a year-on-year (YoY) basis, while economic growth is expected to accelerate for the rest of 2021. The US 10-Year Treasury note (US10YT) has sharply increased, peaking at 1.75% in March, and has since been moving sideways around the 1.6% level. These are signals indicating that inflationary pressures are building up, despite the Fed’s loose stance on interest rates. Based on the recent comments of Fed Chairman Jerome Powell, the Fed is patient to keep the easing monetary policy intact - near-zero interest rates and $120 billion in monthly bond purchases even though the economy is recovering strongly. Besides, we do expect more fiscal stimulus from Biden's administration in the coming months to further pump up the economic recovery. Inflation fear has caused the recent market volatility and corrections (especially in the Tech sector and bond markets). In the recent earnings announcement, most companies are seeing an increase in profits and positive business outlooks and business activities (some do review their concern on rising prices in commodities and inflation risk). However, their share prices are showing the opposite and some investors take this chance to cut down their positions or take profits after a year plus of great performance. Stay Invested: Tech is not over yet but becomes healthier and remains profitable after correctionsWe take this fear of inflation as the opportunity to look into the Tech sector. Due to the superior appreciation since Covid-19, we believe that a lot of investors are still holding onto many positions in the Tech sector and waiting for it to rebounce. Despite the strong earnings and growth of business in 1Q21 and 2Q21, many Tech stocks, ETFs and mutual funds are having a good discount of 5% to 15% on average from their recent peaks at the moment. Investors can do some regular investment plans and enter at lower prices to dollar-cost average the Tech positions in their portfolio over time. Mitigate the risk of inflation by adding alternative asset classes into your portfolioThere are a few asset classes that usually perform better under an inflationary environment. For example, commodities, gold, inflation indexed funds, REITs, consumer staples etc. Commodity prices have risen sharply since the start of 2021 along with the yield of US10Y and they still have the momentum and support from the increase of economic growth globally. Major commodities like oil, corn and copper have risen 87%, 93% and 83% respectively in one year. With the outlook of strong demand, investors can look into mining companies or ETFs and raw commodities to add into their portfolio to hedge against inflation risk.

Semiconductors are regarded as the new ‘oil’ and strategic material among the advanced economies nowadays, especially for the Tech sector as it is greatly needed to push for green energy, autonomous industry, artificial intelligence and even space exploration. The effort to use more green energy and commitment to fight climate change by the developed markets and emerging markets are larger than ever before. We have had a global shortage of semiconductors since the start of 2021, impacting the Tech sector, car manufacturers and every other sector that requires a semiconductor. Although semiconductor companies like TSM have invested heavily to build new production plants, the supply is relatively inelastic and unable to catch up with the booming demand. However, the prices of semiconductor companies are underperforming recently due to inflation fears but over time, they should be a good investment due to their profitable business and growing demand for semiconductors in green energy, artificial intelligence, cloud computing, autonomous machines etc. On average, the price level of the semiconductor sector has dropped about 15% since the peak in Feb 2021. It should still remain attractive and strong going forward as the producers generally can pass the costs to consumers when the demand outpaces the supply. TIPS + REITs: For conservative Investors to hedge against inflation riskInvestors can look into Treasury Inflation-Protected Securities (TIPS) investment in order to cover themselves from intermediate-term inflation. It usually consists of liquid and well-diversified portfolios of government bonds with a short duration. The volatility of TIPS is low and the face value rises with inflation. It is a good way to park the cash while waiting for chances to enter the markets (like Tech, semiconductor etc). Investors can invest via TIPS ETF to gain exposure and rebalance their portfolio with TIPS when necessary.

However, it is worth noting that TIPS are trading at historically expensive levels right now, with real yield in the negative territory.Tangible assets like properties and REITs are popular investments under an inflationary environment. The demand for property and the yield of the property rental market is strong and steady when the economy is growing. This is even further boasted and continuously supported by near-zero interest rates of the Fed and central banks around the world. Investors can look into REITs for good dividends and capital appreciation in the short to medium term to hedge against inflation.The bottom line? Markets will remain volatile this year as there are still uncertainties for interest rates to go up with inflation and whether the Fed and central banks will start tapering due to expected strong economic data. Meanwhile, it is a good opportunity for short-term trading and portfolio rebalancing to alternative asset classes for diversification as the landscape of investment has changed due to inflation. Investors may grab the chance to buy low and hold for the long-term, especially those discounted sectors like Tech and semiconductor due to inflation fear in recent months. Interested investors may refer to our Kristal.AI ETF Focus List below for investment opportunities and ideas:

All information is accurate as of time of publishing.

By

C K Wong

May 7, 2021

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