Vantage Point: Investing in recessions  

What will look good when inflation comes down?

What will look good when inflation comes down?
Jacob Vijverberg, Aegon Asset Management

Inflation is set to slide downhill in 2023 from the giddy heights it reached in 2022, but what sort of investments will look good for investors when inflation falls?

According to Aegon Asset Management's multi-asset manager Jacob Vijverberg, investors will need to "rethink" their asset allocation.

Vijverberg explained that some of the factors that have caused inflation to rise in the past two years - such as the energy crisis and the war in Ukraine, will begin to subside in the coming quarters, with ramifications for portfolio positioning.

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He said: “Monetary tightening should add downward pressure to consumer prices going forward, with the impact of higher rates increasing mortgage and credit rates as well as consumers’ propensity to save.

"We also expect less fiscal support for individuals, and the combined effects should cause inflation to fall as consumption of goods and services declines. A slowdown should also eventually cause stickier forms of inflation, like rent and wage inflation, to decline."

Because asset classes that perform well in an inflationary environment, such as energy, are markedly different to those than do well as it comes down, careful longer-term allocation is essential for investors at a critical moment such as now.

He said: “The real returns of different asset classes over shorter-term periods of declining inflation show that commodities, which have a high correlation to inflation, decline in value in slowing inflation conditions.

"However, the causality is unclear. It could be that commodity prices have themselves been the cause of declining inflation.

“The real returns of other asset classes are mainly positive."

He pointed to the fact that falling inflation generally implies a looser monetary policy, which is supportive of risk assets such as equities.

For example, in the 2008-2009 period known as the Credit Crisis, global equities and real estate investment trusts had sharply negative real returns due to the economic fallout.

Vijverberg commented: “The real returns of other asset classes are more mixed.

"Credit has had negative returns in all falling inflation periods, US Reits have had some positive periods, government debt had one positive period, and global equities two."

Riskier assets 

While it is difficult to predict the progress of inflation, especially as consumers and business have been adapting their behaviours in anticipation of higher prices, Vijverberg said markets were starting to price in inflation falls.

“Markets have begun to price in that inflation will decline, in part due to the action by central banks.

"High inflation levels cannot be sustained – we expect inflation to fall towards central bank target levels over the medium term."

Taking such a scenario into consideration, riskier assets such as higher-yielding fixed income and equities are likely to outperform lower-risk assets such as government bonds over the course of the year, so it would be worth considering portfolio allocations to these.