Making it rain: Asset mix review

I have been discussing our positioning of portfolios for a return of inflation, or maybe better wording is a reflationary environment. As we have been witnessing over the last 12 months, we have seen trillions in government stimulus globally and ultra-low accommodative monetary policy from Central Banks. I often think of an individual holding a stack of hundred-dollar bills in their hand and using their other hand to whisk those dollars into the air as they walk down the street. Hence, making it rain. While the imagery isn’t intended to disparage the hard work of governments and central banks over the last 12 months, as I believe they all did an amazing job in a very uncertain time. There have been a lot of dollars created and made available to a large percentage of the population, and there is still more to come.

While money has been created, the next stage is for the velocity of money to begin to pick up. Money must leave bank accounts and get into the economy through increased wages and spending. Once that is entirely in place, the growth needle starts to move, and reflation begins to occur. Inflation at this point will be a welcome change to the somewhat anemic growth environment we have been living through for several years now. Clearly, central bankers want growth back as the threat of deflation is a lot harder animal to deal with as the Japanese economy has been dealing with for over a decade.

Protecting portfolios from inflation can happen in several ways. An inflation hedge must move alongside inflation, meaning if inflation moves higher, that asset’s value also moves higher. Historically gold has helped fulfill this role, and it may do so again. During some inflationary periods, not all stocks were your friends as companies that can not adjust and pivot to increased wage pressures or can not pass extra costs onto consumers have suffered, as have their share prices. Most bonds do not protect well against inflation, although they still represent an essential element in portfolio construction.

So, what’s the answer? My research tells me that hard assets are still very important inflation protectors. While cryptocurrency may have stolen some thunder from the gold trade, other commodities still offer strong evidence of inflation protection. Infrastructure assets represent another basket of assets that protect against inflation as well. Potentially we should all chip in and buy an airport and a toll road or, at a minimum, use investment vehicles that own those types of assets. Lastly, and there may be some who disagree with me on this; companies who can adjust product/service pricing as input costs increase look a lot like infrastructure-type assets to me. Many of these businesses have a fee-based component to them (like a toll road, for example) and offer flexibility in dealing with costs. We now operate in a much more service-based economy, where constantly having to engage large capital expenditures to increase revenue is not as paramount across certain industries. At a minimum, controlling when those expenditures occur is much more in control of CEOs who can now pivot easily to adjust to a changing environment and capex. 

As the diagram displayed above shows, we are in the early innings of this recovery. As we have begun to see the market being tested this year, the news is also encouraging. With such things as the Archegos Capital Hedge Fund “blow up” in March, as well as a President Biden surprise announcement last week about a proposed policy change to capital gains taxation in the U.S. (reminded me of a surprise Trump tweet). We have seen the reintroduction of political risk back into the market. The markets handled these developments in stride. The technicals of the market have remained intact. Risk is ever-present in the markets, and it is important to remember that the types of market risk ebb and flow depending on what is happening in the world and where we are at on the business cycle. At this time, in my opinion, the biggest risk is not being invested and ensuring your portfolio is poised to benefit from the continued economic growth. Bank of Canada just upgraded our growth for the year, and airlines are now ramping up in response to the speedier recovery and the by-product of that growth being a healthy reflation in prices.