The US asset manager expects inflation to be slightly below 2% for developed economies over the next 10-15 years, despite the unprecedented fiscal and monetary stimulus. ‘We expect a lot of volatility in the short term, with inflation possibly temporarily exceeding central bank targets. But in the medium term, we will return to the pre-pandemic structural trends,’ says Vincent Juvyns, macro strategist at JP Morgan AM.
He says the crisis has done little to change inflation expectations. He sees no signs of a decline in globalisation, as some market analysts predict. ‘On the contrary, imports from China and other countries have risen sharply in the past year. Globalisation keeps the wind in its sails and will continue to weigh on inflation.’
What remains is the impact of monetary policy on inflation. ‘That policy was already very loose before corona and did not stimulate inflation. But now there is a much more aggressive fiscal policy in the US and Europe,’ Juvyns notes.
‘They are investing mainly in the energy transition, partly with the aim of bringing down the prices of sustainable energy. It remains to be seen whether these investments will have an inflationary impact. This entails a great deal of uncertainty for the next two years, but over a period of five to ten years the inflation environment will be the same as it was before the corona crisis,’ he says.
Inflation hedge
In this scenario, global developed equity markets could return 3.5% per year in euros (or 4.6% in local currency), JP Morgan AM expects. ‘In principle, equities are a very good inflation hedge. Even companies with less pricing power are usually able to raise prices in line with inflation. In the past, equity markets have also risen as interest rates rose, although some sectors are obviously more sensitive to this than others. It only becomes a problem if inflation is not under control, and interest rates have to be raised quickly.’
JP Morgan AM’s research on this has shown that as soon as US 10-year yields rose above 4.5% in the period 1965-2009, the equity market came under pressure. Juvyns says: ‘Thanks to the actions of central banks, this threshold is now much lower. From the credit crisis in 2009 until today, that critical interest rate level was 3.6%. We are still a long way from these pain points and do not anticipate these interest levels coming back for the time being.’
Real assets
With all the fiscal and monetary stimulus that’s now happening, there is nevertheless a small chance of a sharp rise in inflation in the coming years, according to JP Morgan AM.
In both scenarios, investors should look for solutions to still generate returns, says Juvyns. ‘We strongly believe in real assets, with a slight preference for infrastructure over real estate. Infrastructure offers the opportunity to benefit from additional government investments that are being planned. Both categories have an option in their contracts allowing to increase prices with inflation. There is some delay in this. In the short term, therefore, the relationship is not perfect, but in the long term they offer good inflation protection.’
For example, JP Morgan AM is investing in the latest generation of LNG carriers, which it will lease to third parties. ‘Because governments want to make their economies more sustainable, there is more demand for natural gas in the world, which gives us pricing power’. In real estate, JP Morgan AM finds logistics and data centres for cloud computing, both of which are strongly correlated with e-commerce, most attractive.
JP Morgan AM recommends financing the allocation to real assets by reducing the weighting of bonds, as fixed-income securities are most vulnerable to inflation. ‘Due to increased valuations, we have lowered the expected long-term returns for all asset classes except real assets.’ For global infrastructure and European real estate (excluding UK), JP Morgan AM expects total returns to average 4.7% and 5% in euros per year respectively over the next 10-15 years.