After dominating the investment landscape in 2022, inflation is now expected to peak in the next few months, according to a new outlook from Aviva Investors.
However, the firm has warned that investors may still be underestimating the risk of inflation getting stuck on the way down, which Aviva suggested would lead to renewed interest rate rises from central banks and could potentially hamper company earnings.
“The key risks we are watching most closely are sticky components of inflation, particularly wages, and evidence of declines in earnings,” the firm said.
“For markets, this means that, unless and until growth weakens to a point where central banks start reducing rates, there will still be episodes where equities and bonds move in tandem.”
Aviva predicted that, between now and the end of the first quarter, both the year-on-year and monthly rates of inflation are likely to slow across most developed economies.
The firm pointed out that goods price inflation and energy prices are already slowing, along with housing-related inflation in the US, which is a key component of consumer price indices.
“As this unfolds, investors and central banks will keep a close watch on the rest of the service sector, which is typically driven by labour costs,” said Aviva.
“A key question is whether inflation will fall to levels that allow central banks to stabilise interest rates. Another is whether the ultimate path of rates slows the economy modestly or leads to a deeper recession, threatening company profits.”
On how to position their portfolios for inflation, Aviva stated that investors needed to be adaptable instead of setting a strategy and assuming it would work for all kinds of inflation.
“Cash is valuable, despite its negative real interest rate, because it helps with the readjustment and reorientation of portfolios. In our tactical armoury, being able to put cash to work at the right time is a weapon we will use,” the firm said.
“It allows us to use higher cash balances to protect portfolios and deploy them when there are good opportunities, so clients can escape the burden of trying to time their investments.”
Over the coming quarters, Aviva indicated that does not expect the negative correlation between equities and bonds to return unless a deep economic downturn leads to much lower interest rates, which it noted is a possibility for 2023 but not the firm’s base case.
Jon Bragg
Jon Bragg is a journalist for Momentum Media's Investor Daily, nestegg and ifa. He enjoys writing about a wide variety of financial topics and issues and exploring the many implications they have on all aspects of life.
