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How high inflation impacts various asset classes - and why you should invest differently

Sharmini Ravindran

CMO at Dezy
Published on 26.07.2022
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Times have changed – and so should your portfolio

Inflation in the United States has officially hit 9.1% as of mid-July 2022. Inflation of this magnitude in the world’s largest economy and reserve currency will certainly have serious spillover effects around the world.

In Singapore, we’ve also begun to observe prices of everyday goods and services creeping up – both anecdotally and objectively as measured by the Consumer Price Index and MAS Core Inflation metrics.

For a deep dive into how much exactly prices have gone up, check out our previous article about inflation in Singapore.

High Inflation Affects Not Only Your Bottom Line

We’ve previously covered how severe inflation is in Singapore. We should realise that high inflation does not only affect how much we can buy with the money we have. In fact, high inflation has far-reaching effects on the wider economy, including the stock market, property sector, and other financial asset classes.

After being spoilt by more than a decade of universally low-interest rates, investors need to awaken to a new reality and adapt their investment approach and portfolio composition accordingly. Investing ‘business as usual’ would not be wise amid a fiscal landscape that has already changed.

#1 The Stock Market

There have been many studies that attempt to figure out how the stock market is affected by high inflation – with no conclusive results. This is understandable since it is almost impossible to study both these phenomena in isolation.

On the one hand, high inflation might prompt more investors to invest, since this is one way of preserving the purchasing power of their savings. On the other hand, high inflation might place a real strain on many households’ finances, reducing the amount of disposable income that could be used for investment purposes. Investors might also have a less buoyant outlook on the economy, thus negatively impacting company valuations.

Historically, high inflation is rarely allowed to continue unabated. As with past bouts of high inflation, central banks like the United States Federal Reserve have deployed countermeasures like raising the interest rate in an attempt to moderate the money supply, as well as reduce demand-side pressures. These steps make it more challenging for companies to grow while making the cost of financing higher as well.

Source: S&P Dow Jones Indices

For example, the S&P500 index saw negative returns of -17.4% year-to-date (YTD) [as of 19 July 2022], which can be contrasted with rally after rally even during worst of the COVID-19 pandemic in 2020 and 2021.

#2 Bonds and Fixed Income

Bonds are traditionally viewed as a safe haven instrument, since they are less volatile than stocks, and provide the stability of regular coupon payments. As explained earlier, high interest tend to precede the raising of interest rates, as the US Federal Reserve has already done – and are expected to continue to do.

With high interest rates, newly-issued bonds will also have correspondingly high yields, which make them even more attractors to investors. However, it might be harder to find new bonds to purchase, since companies and governments may be more prudent in their debt issuances (especially for long-dated bonds) given the high cost of doing so.

At the same time, existing bonds in the market would see their value fall, since investors would prefer to offload these lower-yielding bonds.

Source: S&P Dow Jones Indices

Since there are much more issued bonds than newly-issued bonds in the market, the net result of bond performance generally as an asset class is negative. This is borne out by the S&P 500 Bond Index returning -12.8% YTD [as of 19 July 2022].

#3 Cryptocurrencies

Even though cryptocurrencies have not been around long enough for a firm understanding of how they perform amidst various economic cycles, there are some clues for discerning investors who want to understand how high inflation affect cryptocurrency prices.

While there can be a virtually infinite variety of cryptocurrencies that can be invented, minted and circulated, there is a finite amount of fiat currency that people possess in order to purchase cryptocurrencies.

Those who invest in cryptocurrencies in order to grow their real-world wealth might find that there might be a slowdown in price growth of major cryptocurrencies, since new and existing investors may have reduced appetites for more adventurous investments.

Source: S&P Dow Jones Indices

Correspondingly, the S&PP Cryptocurrency MegaCap Index returned -51.67% YTD [as of 19 July 2022]. Having said that, current ‘crypto winter’ may have more to do with high profile cryptocurrency scandals and scams, though grappling with high inflation in the traditional financial system certainly isn’t doing any favours to the cryptocurrency market.

#4 Commodities

By definition, inflation occurs when more money is needed to purchase a given set of goods and services. Conversely, with high inflation, the value of commodity goods increases. Thus, we can appreciate why commodities do well in times of high inflation (and even hyperinflation).

Perhaps the only challenge that holders of commodities need to grapple with is when to sell their investments. Investors also need to watch the moves of governments carefully, since it would not be economically and politically tenable for the price of commodities to remain sky high.

Governments might release stockpiles of commodities, seek out alternatives to precious goods, or alter their industrial output to reduce the reliance (and thus demand) on these commodities. Even ‘irreplaceable’ commodities like oil can see their value plateau if consumers decide to drive less, fly less, and buy less.

Source: S&P Dow Jones Indices

The S&P GSCI Gold Index returned negative 5.5% YTD, with less volatility compared to other asset types discussed above [as of 19 July 2022].

Oil, on the other hand, rallied due to supply-side disruptions all around the world. The Dow Jones Commodity Index for Crude Oil is up 33.94% YTD.

Source: S&P Dow Jones Indices

#5 Investment Properties

Like commodities, investment properties tend to do well in periods of high inflation, to which higher rentals could be a contributing factor. If you’re fortunate enough to be a landlord, you could see an upward trend in the rental market, though if the entire economy is in the doldrums, everyone loses out.

As highlighted in the earlier section, governments and central banks typically try to temper high inflation by increasing interest rates, so if you still have outstanding mortgages, you might see your monthly repayments rise once the lock-in period expires.

Flash estimates of Singapore’s private residential property price index indicates it is expected to increase by 3.2% in 2Q2022, following 1Q2022’s increase of 0.7%.

Source: Urban Redevelopment Authority of Singapore

High Inflation is a Mixed Bag, Depending on Your Asset Class

As we can see from the preceding sections, a climate of high inflation is good for some asset classes and bad for others. If your investment portfolio or retirement plan was created in an era of low inflation, it is perhaps timely to do a thorough review to see if assumptions and rationale made during that time still held true.

This is all the more true if you were risk averse and wanted to ‘just’ hedge against inflation. Instruments that deliver low returns might have been adequate during times of low inflation, but with recent developments in the global and local economy, you might need to diversify into higher-yielding products.

Dive deeper into inflation and what it means for you.

In our inflation 101 series, we endeavour to shed light on what inflation is, and how you can beat it. Dive into our previous articles to brush up on your understanding of the macro forces that lead to inflation:

- What is inflation?
- What do interest rates have to do with inflation?
- What is the inflation rate in Singapore, and what can you do about it?

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