PERSPECTIVE3-5 min to read

Inflation protection is becoming more and more important

Economy and financial markets July 2021: Price pressure on raw materials and on the labour market due to production not being able to ramp up quick enough.

01/07/2021
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Read full reportQuarterly Report 2Q2021 English
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Authors

Giovanni Leonardo
Investment Wealth Management
Norbert Brestel
Head of Investment Solutions Switzerland

The growth outlook for the coming quarters remains promising. Expansionary monetary policy is supporting the global economy and has already resulted in excess demand. Production cannot be ramped up quickly enough at present due to a scarcity of resources and there is an emerging risk of overheating. This is creating price pressure on raw materials and on the labour market, which sooner or later will lead to inflation. In response to this inflation scenario, we are keeping an overweight in equities and prefer inflation-protected fixed-income investments and gold over government bonds.

Propped up by continued easy money and generous state aid, the global economy and stock markets have staged an especially speedy recovery from the more temporary external pandemic shock. The basic assumptions of the “temporary external shock” are a key pillar of the global market recovery, as such shocks are quickly resolved by the economy. In my view, however, Covid remains a major risk factor and we need to keep a close eye on the situation until the pandemic is behind us, which unfortunately is not the case quite yet.

Rising corporate profits and strong global economic growth, the likes of which we have not seen for a long time, are supporting equity valuations and weighing on risk-free investments. However, the other side of the coin cannot be ignored. The financial system has become increasingly fragile as a result of extremely expansionary monetary policy. After decades of deflationary pressure (due to an ageing population, productivity growth and globalisation), central banks have had to resort to more drastic monetary means to stimulate the economy, with rising asset prices and increased lending fuelling consumption and driving economic growth.

This has resulted in huge mountains of debt and growth that is increasingly dependent on high asset prices, which in turn have become more and more reliant on low interest rates and financial injections by central banks. Debt in relation to gross domestic product has risen even further in the wake of Covid and has assumed previously unimaginable proportions. Signs of speculative excesses are increasing, including crypto-mania, SPACs and the massive increase in debt financing.

Our economists have once again upgraded their growth expectations for this year and next. For the coming year, they expect the Fed to tighten monetary policy as the spectre of inflation slowly but surely raises its head. Inflation expectations have become the main risk driver in recent months. Central banks are currently poised at the ready; they are still willing to accept slightly higher temporary inflation, but this could change relatively quickly at any time.

In our investment strategy, we prefer investments that can hold their own in a moderate inflation scenario. We have an overweight in inflation-linked bonds and gold at the expense of government bonds, and we are keeping an overweight in equities as well. Equities in particular have proven to offer good inflation protection in periods of moderate price increases. During the last quarter, we reduced our underweight in value stocks at the expense of growth stocks and controlled the portfolio risk through profit-taking in view of risk considerations.

Giovanni Leonardo 

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Read full reportQuarterly Report 2Q2021 English
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Authors

Giovanni Leonardo
Investment Wealth Management
Norbert Brestel
Head of Investment Solutions Switzerland

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