Goldman’s Wall Street Pros to JPMorgan on the new era of inflation

Photographer: Michael Nagle / Bloomberg

It is the invisible force that rocks Wall Street: a rebirth of inflation for the post-blocking era that can change everything in the world of cross-asset investment.

As America’s flirtation with the sizzling economy sends prices derived from the market expectations to the highest in more than a decade, Bloomberg solicited the opinion of the main money managers on their success or failure hedge strategies in the future.

One lesson: the economics of trading stocks and real estate at interest rates would be turned upside down if uncontrolled price projections were believed.

However, there are clear divisions. Goldman Sachs Group Inc. says commodities have proven their worth over a century, while JPMorgan Asset Management is skeptical – preferring to hide in alternative assets like infrastructure.

Pimco, in turn, warns that the market’s obsession with inflation is out of place, as central banks are still potentially set to exceed targets in the next 18 months.

The comments below have been edited for clarity.

Alberto Gallo, partner and portfolio manager at Algebris

• Likes hedges, including convertible bonds and commodities

We do not know at the moment whether the recovery in inflation will be sustained, but it is a good start. What we do know is that the markets are positioned in a completely wrong way. Investors have been buying QE assets, such as Treasury bonds, investment-grade debt, gold and technology stocks. They have been long on Wall Street and short Main Street for a decade.

There will be a rotation for real economy assets, such as small caps, financial and energy stocks, instead of rates and credit, and this will generate a lot of volatility. We like convertible debt in value sectors that are linked to an acceleration of the cycle. We also like commodities.

We are moving from an environment in which central banks have pressed the accelerator, keeping interest rates low while governments have put austerity on the handbrake, to one where governments and central banks are now working together.

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

• Prefer real assets over commodities and price-protected bonds

Commodities tend to be volatile and do not necessarily offer good protection against inflation. As for indexed securities, our study showed that their long duration exceeds the pure inflation compensation that this asset offers. It is not the main asset on our inflation protection list.

If inflation rose and continued to rise – and we think it is a low probability event – the recovery-oriented equity sectors offer a good investment profile. We also like real assets and the dollar.

We expect volatility in inflation, especially at the main level in the coming months, mainly in the 2Q, driven by base effects, excess demand in the short term and interruptions in supply chains caused by a long blocking period. We see this as transitory and expect central banks to examine short-term volatility.

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

• Issues alert on indexed bonds and gold

We found that during a scenario of high inflation, commodities, especially oil, are the best protection. They have the best record of the past 100 years to protect you from unforeseen inflation – driven by the scarcity of goods and services and even wage inflation like that of the late 1960s. Shares have a mixed record. We like value shares, as they are short-lived.

The biggest surprise is gold. People often see gold as the most obvious protection against inflation. But it all depends on the Fed’s reaction to inflation. If the central bank does not anchor back-end yields, gold is probably not a good choice, as real yields may go up. We see bonds indexed in the same field as gold.

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

Nicola Mai, sovereign credit analyst at Pimco

• Says inflation may exceed central bank targets over the next 18 months

Looking through the short-term volatility introduced by energy prices and other volatile price components, we see inflation remaining low in the short term, with central bank inflation targets elusive over the next 18 months or more. The global economy has an idle capacity to accommodate growing demand. However, if spending increased steadily over the years, it would likely result in higher inflationary pressures.

In general, we like curve strategies and think that the US TIPS offers reasonable insurance against excess inflation. Commodities and assets linked to the real estate market are also expected to benefit in an environment of high inflation.