The monthly reports from the consumer price index have become much less scary in a lot of places. Streams of heavy interest rate hikes in the US, UK, and Europe (among other places) have brought red-hot inflation back down toward the central banks’ more temperate 2% target. And though policymakers are quick to point out that the job’s not quite done, it’s clear that things have become considerably cooler.
So it’s worth taking a look at how this newer, lower inflation moment might affect your portfolio and how likely it is to last.
Can stocks keep their good run going?
Company shares have seemed more unsteady this month than they’ve been in a while. And that’s mostly because some recent signs of a slowdown in the US economy have got folks worried about a possible recession. A string of less-than-spectacular quarterly earnings updates from the glittery tech giants hasn’t helped matters either. So jittery investors have been selling their stocks and pocketing the profits they’ve made, just in case.
But despite the recent plunge in share prices – which saw the S&P 500 fall about 5% in a week – the outlook for stocks in a lower-interest-rate, low-inflation environment is generally considered to be pretty rosy. What’s more, a “pullback” of 5% or more isn’t all that unusual, says Bank of America. Its research shows there have been three of those per year, on average, since the 1930s.
The fact is that falling inflation and falling interest rates should stimulate economic growth – all else being equal – and that’s good news for company profits. Plus, share valuations tend to rise when interest rates fall, as returns on cash-like investments get squeezed, making the stock market more attractive.
In other words, it’s possible that investors are just being overly gloomy. That’s what Invesco suspects: the fund managing house says a recession doesn’t appear to be imminent, especially if you look at the US jobs market, which still appears fighting fit.
The fund management firm says it’s expecting stocks to remain volatile for a while, and says that may well be a lucky thing. The little sell-offs along the road could bring some nice buying opportunities for all the patient investors who’ve been keeping a little cash on the side.
Are bonds ready for a comeback?
The bond market is back to proving its worth as a diversifying tool, while also providing investors with a valuable income stream.
Bond prices are highly sensitive to interest rates, of course, and the recent run of rising interest rates generally caused them to fall in value, bringing yields in line with market rates. (Remember bond prices fall as yields rise, and vice versa.) That’s why bonds dropped by so much in 2022 – investors had to reprice existing securities because new bonds were being issued with higher interest rates.
Recently, bond prices have been rising – and that’s thanks to those worries about a slowdown, and the expectation that central banks will be forced to lower interest rates to keep their economies and job markets humming along. Now that inflation is near the target again, they’ve got more freedom to do so, with less fear that it will reignite inflation.
So that suggests this might be a good time for safe-haven government bonds, from places like the US, the UK, or Europe.
But it could also be a good time for short-dated corporate bonds. Fidelity International, the fund managing giant, says that with their yield advantage over government bonds, they’re the fixed-income market’s sweet spot. See, the short end of the curve is influenced more by interest rate changes than the longer end. And when central banks start cutting rates, they tend to see a bigger positive impact.
Could gold be ready to shine?
Quite possibly: the glittery metal and the companies that mine it do generally take a real shine to falling interest rates.
Gold’s been in high demand lately with global central banks buying up brickloads of the stuff, as they seek to diversify their vast reserves away from the US dollar. Plus, America’s interest rates are set to fall, and that’s generally a positive for gold’s price. Gold miners, as well, are likely to benefit, especially because their operations become increasingly profitable as the price of the metal rises.
Wealth manager Charteris sees gold rising above $3,000 an ounce over the next six to 12 months, from roughly $2,400 now. The firm says an increase in global debt levels or geopolitical risks could accelerate the move for the safe-haven metal.
And, last, is high inflation truly beaten?
Well, consumer price rises were officially below 3% in the US, Europe, and the UK in July – and generally moving closer to the standard central bank target of 2%. Still, some pros caution that the world’s economies might continue to see a bit more inflation volatility from here on out.
UK-based wealth manager Ruffer says part of the problem is the ever-growing government debt in many places, and the fact that leaders seem to believe in a “magic money tree”. Because of that, the firm says, government bonds aren’t the safe-haven they used to be.
Its solution is to buy inflation-linked bonds and short-dated bonds and to avoid most stocks. Indeed, its flagship investment trust holds about 33% of its assets in short-dated bonds and about 20% in inflation-linked bonds. About 11% of the portfolio is in UK shares, which are cheaper than global peers.
The firm says the bull market in stocks is simply running out of positive surprises, and with valuations so high, that could make for a dangerous situation.