After an eight-day record setting streak, the S&P500 index takes a breather in the context of renewed fears about rising inflationary pressures. The debate rages on whether current inflation numbers are merely reflecting a transient situation borne out of the COVID-19 aberrations or if we are actually witnessing a major comeback of an old enemy.

On Wednesday, official data showed the largest increase in CPI numbers in 31 years, a 6.2% increase in prices year over year.  More data points like this one and the Fed will feel significantly more pressure to raise rates sooner and faster in order to keep the economy in check.
Markets are giving mixed signals on their expectations about monetary policy; on one hand, in spite of the last couple of days of cooling off action, the equity markets are still behaving as everything will be alright.  The fixed income market is more tentative, with days when the yield curve seems to flatten more than it should (possibly the result of fears that the Fed will act aggressively to stall inflation) and days when the long end of the curve seems more open to the idea of a future defined by higher prices and simultaneously a still accommodating central bank.

Naturally, getting the development of the inflation story right will be a major factor in producing good returns going forward in an environment where admittedly investors should be realistic about expectations.  The Long -Term Capital Market Assumptions report by JP Morgan was just recently released and it signals an expected annualized nominal return for the next ten years in a 60/40 portfolio of just 4.3%.  Government bonds are seen as the clear looser in the next monetary and economic cycle and the weakest link in the most traditional 60/40 allocation.  Diversified domestic equity allocations are also not expected to hit the ball out of the park as a function of high valuations, rising rates and in the case of inflation being “higher for longer” compressing margins.

However, not all hope is lost in generating higher returns. One must recognize that conventional decisions might not be the best course of action and must think creatively.  Volatility will be higher in almost any portfolio combination and time horizons will have to be lengthened as a result.  Real assets should be an increasing part of the mix - from real estate to selected commodities – and credit risk should substitute interest rate risk.  And for those whose financial profile allows it, a significant switch to alternatives should be considered.

Feel free to reach out to our team for a more detailed conversation about repositioning your portfolio.