Inflation and rotation: Investors must prepare for a recession

While there are signs that inflation may be starting to cool after reaching a 40-year high in May,[1] there is a broad consensus that rising prices will be with us for some time. U.S. Treasury Secretary Janet Yellen recently acknowledged that she had been mistaken in previously describing inflation as “transitory.”

Yellen and many others had not anticipated that Covid-19’s lingering effects on supply chains would be exacerbated by the ongoing impact of the war in Ukraine on food and energy prices. In this new reality, the World Bank is warning of a heightened risk of global “stagflation” – a term that became prominent in the 1970s to describe a period of high inflation accompanied by weak or negative growth.

There is some cause for optimism. The U.S. core personal consumption expenditures (PCE) price index – which excludes volatile food and energy prices to give a clearer indication of persistent price pressures – moderated in March and April after peaking in February. Most economists expect inflation to remain elevated for a while, though, and certainly considerably higher than the 1.5% to 2% range that had become normal before the pandemic.[2]

Importantly, there are broader factors contributing to persistent price pressures than the post-pandemic rebound in consumption and supply chain glitches.[3] First is the reversal of globalization amid rising tariffs and efforts to diversify supply chains, which has made imports more expensive. Second is the fact that the working-age population in China – often described as the world’s factory – has been shrinking steadily since 2011 as the country’s population ages.[4] Third are the costs associated with the transition to net zero emissions as the world seeks to limit climate change. Finally, in the U.S. in particular, a housing shortage is also pushing up prices.

Inflation opportunity

These factors are fanning the flames of persistent inflation, which is fuelling expectations of sharper interest rate hikes.[5] That, in turn, has increased the likelihood of recession. The U.S. Federal Reserve puts the probability of a recession over the next four quarters at slightly more than 50%.[6] And 70% of economists polled by the Financial Times and the University of Chicago Booth School of Business said a recession would strike by 2023.[7]

But these same inflationary factors also provide clues as to how investors might adjust their portfolios to weather that increasingly likely economic downturn.

The quest for supply chain resilience and China’s declining labor force, for instance, could be an opportunity for Vietnam and other Southeast Asian nations to pick up China’s slack.

Suppliers of healthcare as well as technology that enhances workforce productivity also stand to benefit from the broader trend towards aging populations. And though traditional energy stocks may have performed well over the past year while clean energy plays have declined in tandem with the growth stocks more broadly, that may give way to a resurgence of investment in renewables as the focus on climate goals recovers.

Other sectors traditionally viewed as resistant to inflation include dividend-paying utilities along with consumer staples, discount retailers and the logistics companies that serve them. Banks, mortgage lenders and insurance companies may also profit from rising interest rates.

Investors may also be tempted to increase their exposure to private real estate, betting on long-term demand for bricks and mortar as a hedge against inflation. But that comes with the caveat that mortgages are becoming more expensive, increasing the chances of a housing market correction.

Taking a broader, longer view

Moreover, investors may take this opportunity to reconsider geographical diversification. To be sure, where the US economy goes, much of the rest of the world follows, and the World Bank has adjusted its growth expectations across the board. But economies in Southeast Asia, South Asia, the Middle East and North Africa are still expected to register fairly robust growth in 2022 and 2023.[8]

Whatever an investors’ current positions, it often pays to take the long view and remain invested during downturns rather than selling and returning to the market at some point in the future.[9]

Securities-backed financing can offer an efficient and cost-effective way for investors to diversify their exposures in a changed environment while retaining the upside potential of their core holdings. Borrowing at a low and fixed cost can also be an attractive strategy in an inflationary environment, as borrowers repay less in real terms.

Today’s inflationary environment and the looming prospect of a recession certainly increases risks, but nimble investors can also identify undervalued assets – whether in equity markets or elsewhere – during times of dislocation. Securities-backed financing can help sophisticated investors capitalise on those opportunities.


[1] https://www.reuters.com/markets/us/us-faces-unacceptable-levels-inflation-yellen-tells-senators-2022-06-07/

[2] https://www.bloomberg.com/news/articles/2022-05-13/age-of-inflation-in-us-will-last-much-longer-than-pandemic-spike

[3] https://www.bloomberg.com/news/articles/2022-05-13/age-of-inflation-in-us-will-last-much-longer-than-pandemic-spike

[4] https://www.chinadaily.com.cn/china/2016-11/21/content_27444998.htm

[5] https://www.reuters.com/markets/us/fed-seen-raising-us-interest-rates-further-battle-hot-inflation-2022-06-10/

[6] https://www.wsj.com/articles/fed-paper-finds-elevated-probability-of-recession-11655900645

[7] https://www.ft.com/content/1bd49ace-b741-455a-8499-a91828d7ad5c

[8] https://www.worldbank.org/en/news/press-release/2022/06/07/stagflation-risk-rises-amid-sharp-slowdown-in-growth-energy-markets

[9] https://www.morganstanley.com/articles/top-5-investor-mistakes

Disclaimer

Past performance does not guarantee future returns, and individual returns are not guaranteed or warranted.

This Document is intended solely for accredited investors, sophisticated investors, professional investors, or otherwise qualified investors, as may be required by law or otherwise, and it is not intended for, and should not be used by, persons who do not meet the relevant requirements. The content provided herein is for informational purposes only and is general in nature and not targeted to any specific objective or financial need. The views and opinions expressed in this Document have been prepared by third parties and do not necessarily reflect the views and opinions of EquitiesFirst.  EquitiesFirst has not independently examined or verified the information provided herein, and no representation is made that it is accurate or complete.  Opinions and information herein are subject to change without notice.  The content provided does not constitute an offer to sell (or solicitation of an offer to purchase) any securities, investments, or any financial products (“Offer”). Any such Offer shall only be made through a relevant offering or other documentation which sets forth its material terms and conditions. Nothing contained in this Document shall constitute a recommendation, solicitation, invitation, inducement, promotion, or offer for the purchase or sale of any investment product by First Holdings, LLC or its subsidiaries (collectively, “EquitiesFirst”), nor shall this Document be construed in any way as investment, legal, or tax advice, or as a recommendation, reference, or endorsement by EquitiesFirst. You should seek independent financial advice prior to making an investment decision about a financial product.

This Document contains the intellectual property of EquitiesFirst in the United States and other countries, including, without limitation, their respective logos and other registered and unregistered trademarks and service marks. EquitiesFirst reserves all rights in and to their intellectual property contained in this Document.  The Document should not be distributed, published, reproduced or otherwise made available in whole or in part by recipients to any other person and, in particular, should not be distributed to persons in any country where such distribution may lead to a breach of any legal or regulatory requirement.

EquitiesFirst make no representation or warranty with respect to this Document and expressly disclaim any implied warranty under law. You acknowledge that EquitiesFirst is not liable under any circumstances for any direct, indirect, special, consequential, incidental, or punitive damages whatsoever, including, without limitation, any lost profits or lost opportunity, even if EquitiesFirst has been advised of the possibility of such damages.

EquitiesFirst makes the following further statements that may be applicable in the stated jurisdiction:

Australia: Equities First Holdings (Australia) Pty Ltd (ACN: 142 644 399) holds an Australian Financial Services Licence (AFSL Number: 387079). All rights reserved.

The information contained on this Document is intended for persons located in Australia only and classified as a Wholesale Client only as defined in Section 761G of the Corporations Act 2001. The distribution of information to persons outside this criteria may be restricted by law and persons who come into possession of it should seek advice and observe any such restriction.

The material contained in this Document is for information purposes only and should not be construed as an offer or solicitation or recommendation to buy or sell financial products.

The information contained in this Document is intended to be general in nature and is not personal financial product advice. Any advice contained in the Document is general advice only and has been prepared without considering your objectives, financial situation or needs. Before acting on any information, you should consider the appropriateness of the information provided and the nature of the relevant financial product having regard to your objectives, financial situation and needs. You should seek independent financial advice and read the relevant disclosure statements or other offer documents prior to making an investment decision about a financial product.

Hong Kong: Equities First Holdings Hong Kong Limited is licensed under the Money Lenders Ordinance (Money Lender’s Licence No. 1681/2023) and to carry on the business of dealing in securities (Type 1 licence) under the Securities and Futures Ordinance (“SFO”) (CE No. BFJ407).  This Document has not been reviewed by the Hong Kong Securities and Futures Commission. It is not intended as an offer to sell securities or a solicitation to buy any product managed or provided by Equities First Holdings Hong Kong Limited and is only intended for persons who qualify as Professional Investors under the SFO. This document is not directed to individuals or organizations for whom such offers or invitations would be unlawful or prohibited.

Korea: The foregoing is intended solely for sophisticated investors, professional investors or otherwise qualified investors who have sufficient knowledge and experience in entering into securities financing transactions.  It is not intended for, and should not be used by, persons who do not meet those criteria.  

United Kingdom: Equities First (London) Limited is authorised and regulated in the UK by the Financial Conduct Authority (“FCA”).  In the UK, this Document is only being distributed and made available to persons of the kind described in Article 19(5) (investment professionals) and Article 49(2) (high net worth companies, unincorporated associations etc.) of Part IV of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (‘’FPO’’) and any investment activity to which this presentation relates is only available to, and will only be engaged in with, such persons. Persons who do not have professional experience in matters relating to investment or who are not persons to whom Article 49 of the FPO applies should not rely on this document. This Document is only prepared for and available to persons who qualify as Professional Investors under the Markets in Financial Instruments Directive.