Back to the future: inflation scenarios for equities

At last, the recovery is underway. Policymakers are focused on employment and investment, central banks remain dovish and businesses suppressed by lockdowns can see a way forward. We believe equity markets offer cyclical reflation and value opportunities in addition to exposure to structural themes – from consumer trends to the low-carbon transition and the rise of Asia.

But there are fears that stimulus-induced expansion could drive an outbreak of inflation. Are they justified?

Not in our view. Our analysis indicates that current inflationary forces are cyclical and this environment provides attractive opportunities for disciplined investors. Looking beyond this cycle, though, we do see potential drivers for a structural rise in inflation. Our equities outlook for the medium and long term is informed by two historical episodes:

• The 1950-65 growth surge: a period of expansion in which central banks accommodated inflation as growth outpaced interest rates, providing an equities tailwind; and
• The stagflation of 1966-81: a time of high inflation, triggering interest-rate hikes that left growth in the dust, stunting the asset class.

History doesn’t repeat, but we believe the current environment rhymes with the 1950-1965 period. As stimulus and societal reopening across the global economy promote recovery, activity stopped by the pandemic is starting again and sectors including transportation and consumer services are rallying. Indeed, the combination of forward earnings, low real interest rates and subdued structural inflation is driving the US equity risk premium above the historical range it has charted since 1960.

Are equity markets going back to the future? If so, how are our portfolios positioned? What balance of quality, growth and value opportunities do we seek? What structural inflation forces are we watching carefully? We answer these questions in our latest investment viewpoint.

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