This means diversifying portfolios across asset classes and selecting positions that can provide stability during periods of high volatility.
Nadine Terman, CEO and CIO of Solstein Capital, is a financial advisor, investment strategist, and regular contributor on CNBC’s program Fast Money. As inflation remains at historically high levels, clients turn to Nadine Terman and her team at Solstein Capital to understand strategies that can outperform.
Understanding inflation trends is key for successful investors. Because inflation impacts all aspects of the economy, including consumer spending and business investment, forecasting the level of inflation and its growth rate is crucial to selecting individual investments as well as positioning portfolios. In periods of decelerating global growth and sticky inflation, Nadine Terman explains that deliberate shifts in equity exposures, fixed income exposures, and real assets can have a meaningful, positive impact on returns.
For Equities, Select Style Factors and Sectors To Outperform During the Late-Cycle Economy.
During a late-cycle economy, the growth of GDP decelerates, and the growth of inflation moves from accelerating to decelerating—even if its absolute level is high, like it is today. Certain equity style factors tend to outperform across these environments, such as High Quality, High Dividend, and Defensives. Also, select sectors tend to outperform, including Real Estate, Healthcare, Utilities and Staples. Nadine Terman and her team at Solstein Capital focus capital on companies with these style factors within these sectors that also offer steady cash flows, consistent profitability, low-debt balance sheets, and revenues that can weather economic uncertainty and potential declines. For example, healthcare companies tend to be less rate-sensitive, have lower exposure to fluctuating input costs, and offer more steady growth prospects.
Nadine Terman of Solstein Capital explains that as investors high-grade portfolios, they do not have to give up on growth. Instead, investors should focus more narrowly on growth businesses that generate a lot of cash that management can reinvest in their business, return back to shareholders, or hold for strategic opportunities that they can take advantage of, when lower quality and slower growth businesses cannot.
For Fixed Income, Timing Is Important (and So Is Watching the Data).
Historically bonds played an important role as a risk-management diversifier for cross-asset portfolios; for example, bonds would outperform when equities underperformed, and vice versa. In the beginning of 2022, though, both equities and fixed income underperformed, so the traditional, historical relationship did not hold. As the Federal Reserve and other central banks around the world began to raise interest rates to combat inflation, fixed income suffered, but so did equities. Normally central banks raise interest rates when the economic picture is improving, not decelerating like in 2022.
The recent summer rally in risk assets was due, in part, to investors changing their view on the path of interest rates and inflation. Investors heard Fed Chairman Jerome Powell’s comments as potentially more dovish than in previous meetings. Current signals from the bond market reflect an optimistic inflation and interest rate outlook, with a Treasury-market-implied inflation rate for 2023 of 3.5%, falling to 2.7% in 2024. July’s core CPI (excluding food and energy) was at 5.9%, a historically high level. If this rosier inflation outlook does not hold, then investors could experience another early-2022 decline in both equities and fixed income, Nadine Terman explains. So, while fixed income historically outperformed in late-cycle environments and during stock market declines, current investor expectations make it important to get the timing right.
One way to position in fixed income is to build the positions incrementally. For example, if your target exposure to fixed income is 25%, then you may buy a small number of investment grade bonds and Treasuries that represent a much smaller percentage of your portfolio today and then increase the number and sizing of the fixed income positions over time as you receive confirming data that (i) inflation is not surprising to the upside beyond expectations and (ii) the Federal Reserve is not hiking interest rates more aggressively than expectations, triggering a hard landing or prolonged economic downturn.
Portfolio Allocations Also Should Include Real Assets, Including Safe Haven Gold.
Real assets play an important role in inflation mitigation for portfolios. Years of underinvestment in cap ex and low levels of inventory were precursors to the pressures caused by wartime supply shocks. As sanctions and other restrictions limit the availability and flow of commodities from Russia and Ukraine, importers must find alternative sources of energy, metal and agricultural products, a dynamic which elevates commodity prices globally. Additionally, a focus on green energy and strategic commodity independence creates a multi-year opportunity for attractive investment opportunities.
Nadine Terman of Solstein Capital explains that in an environment of high inflation, slowing growth, tighter financial conditions and heightened geopolitics, investors should also consider gold within a real assets allocation. During market dislocations, gold often trades as a defensive asset when there is a flight to safety by investors. Thus, gold can provide a buffer to portfolios when other risk assets are declining, a dynamic experienced most recently during the market decline in 2020. With the recent rebound in equity markets, especially here in the US, gold may be an attractive market hedge.
Gold also can trade like a currency and an inflation hedge. Many investors consider gold a store of value that is less affected by the printing of new money and other inflationary factors. That said, gold also can outperform when the growth rate of GDP and inflation decelerate, in effect during the transition from an inflationary environment to a deflationary environment, a transition that Solstein projects may occur over the coming year. Thus, gold may serve a role in different types of risk management hedging for portfolios during challenging times.
Data-Driven Investment Processes Enable Tactical Portfolio Management.
Of course, no investment is guaranteed to be profitable, and it is important to remember that all investments come with a certain amount of risk. This is especially true during periods of high inflation and slowing growth, explains Nadine Terman of Solstein Capital, when markets can experience greater volatility.
Investors always should keep a close eye on macroeconomic data as well as fundamental earnings data and be proactive in their portfolio construction and risk management, according to Nadine Terman of Solstein Capital. This means diversifying portfolios across asset classes and selecting positions that can provide stability during periods of high volatility.
The Bottom Line
Periods of high inflation can be extremely challenging for investors, but deliberate shifts in equity exposures, fixed income exposures, and real assets can have a meaningful, positive impact on portfolios and their returns. Data-driven investment processes can support tactical portfolio management through these challenging times.
