Wall Street Pros from Goldman to JPMorgan in a new era of inflation

Photographer: Michael Nagle / Bloomberg

It’s the invisible force that is turning Wall Street on its head: an inflation recovery for the post-lockdown era that could change everything in the world of cross-asset investing.

Like America’s run-it-hot economy alliance sends a market-derived price according to the highest expectations in more than a decade, Bloomberg asked the best money managers’ opinions on their future hedging strategies.

A takeaway: The economy of trading stocks and real estate for interest rates would be turned upside down if we were to believe runaway price predictions.

Yet there are clear dividing lines. Goldman Sachs Group Inc. says commodities have proven their mettle for over a century, while JPMorgan Asset Management is skeptical and prefers to hide in alternative assets such as infrastructure.

Pimco, meanwhile, warns that the market’s inflation obsession is misguided as central banks may still fall short of targets for the next 18 months.

The comments below have been modified for clarity.

Alberto Gallo, partner and portfolio manager at Algebris

• Loves hedging, including convertible bonds and commodities

We don’t know at this point whether the inflation recovery will continue, but it’s a good start. What we do know is that markets are completely mis-positioned. Investors have been long QE assets such as treasury bills, investment grade debt, gold and tech stocks. They were Wall Street long and short main Street for a decade.

There will be rotation to real economy assets such as small caps, financials and energy stocks instead of interest rates and credits, and that will create a lot of volatility. We like convertible debt in value sectors related to an acceleration of the cycle. We also like raw materials.

We are turning from an environment where central banks pressed the accelerator by keeping interest rates low while governments with austerity pulled the handbrake, to an environment where governments and central banks now work together.

Thushka Maharaj, worldwide multi-asset strategist at JPMorgan Asset Management

• Prefers real assets to commodity and price protected bonds

Commodities are generally volatile and do not necessarily provide good inflation protection. As for indexed bonds, our study showed that their long maturity outweighs the pure inflation compensation these assets provide. It’s not the main asset on our inflation hedge list.

If inflation were to rise and continue to rise – and we think that is an unlikely event – recovery-focused equity sectors offer a good investment profile. We also like real assets and the dollar.

We expect inflation volatility, especially at the headline level, in the coming months, usually above 2Q, driven by base effects, short-term excess demand and supply chain disruption due to a long period of lockdown. We see this as temporary and expect central banks to see through volatility in the short term.

Christian Mueller-Glissmann, director of portfolio strategy and asset allocation at Goldman Sachs Group Inc.

• Provides a warning about indexed bonds and gold

We found that commodities, especially oil, are the best hedge during high inflation. They have the best track record over the past 100 years of protecting you from unexpected inflation – one driven by scarcity of goods and services, and even wage inflation like the one in the late 60s. Stocks have a mixed track record. We like value stocks because they have a short maturity.

The biggest surprise is gold. People often see gold as the most obvious inflation hedge. But it all depends on the Fed’s response to inflation. If the central bank doesn’t anchor the underlying returns, gold is probably not a good choice because real interest rates could rise. We see inflation linked bonds as in the same camp as gold.

A scenario of sustained inflation above 3% and rising is not our base scenario, but that risk has certainly increased compared to the previous cycle.

Nicola Mai, credit analyst at Pimco

• Says inflation could exceed central bank targets for the next 18 months

If we take a look at the short-term volatility caused by energy prices and other volatile price components, we see that short-term inflation remains low, with central banks’ inflation targets set for the next 18 months or so. The global economy has spare capacity to meet rising demand. However, if spending were to be steadily increased over the years, it would likely lead to higher inflationary pressures.

We generally like curve strategies and think US TIPS offers reasonable insurance against inflation overshoot. Commodities and assets linked to real estate should also benefit in an environment of rising inflation.