Inflation posturing divides investors

The Fed gave ‘first warning’ about inflation conversation: Market strategist

Slatestone Wealth chief market strategist Kenny Polcari suggests the Fed is hinting at having the inflation conversation sometime in the fall.

Investors are positioning for the risk of higher inflation as the reopening of the U.S. economy gathers steam, but may not be prepared if the worst of the price increases has already run its course. 

Hot inflation readings, rising expectations, and labor and materials shortages have contributed to the fastest price gains, both for consumers and producers, since the 2008 financial crisis. 

"Looking through the lens of our flows and positioning indicators, we see: strong inflows into inflation-protected bond funds as well as into equity funds focused on Energy, Materials and Financials," wrote Deutsche Bank strategists led by Parag Thatte. 

HOUSING PRICES ARE SKY-HIGH AND KEEP CLIMBING

The inflows into so-called inflation protection assets come as recent surveys from both Deutsche Bank and Bank of America show investors are growing increasingly worried that higher than expected inflation is the biggest risk to markets. 

Data released earlier this month showed consumer prices rose 4.2% year over year in April, making for their biggest annual increase since September 2008. Prices increased 0.8% from the prior month.  

Meanwhile, producer prices jumped 6.2% annually, the most since recordkeeping began in November 2010, and were up 0.6% on a monthly basis.

The Federal Reserve says the recent jump in inflation readings is "transitory" due to a "base effects" skew due to the price decline that occurred at the onset of the pandemic.

To protect against the prospects of a quickening in inflation, investors have since last May been pouring money into inflation-protected bond funds, according to Deutsche Bank. The funds have over the past year seen the strongest inflows since 2010. 

CHICKEN WING SHORTAGE GRIPS AMERICA

On the equity side, energy, materials and financials – sectors perceived to be beneficiaries of higher inflation – have also seen strong inflows, especially since November.   

But commodities, which analysts at Bank of America say are typically a "better diversifier" to equities when inflation is running hot, haven’t been seeing the strong inflows that one might expect. 

Oil futures positioning is in the middle of its historical range. Gold futures positioning, meanwhile, has fallen sharply since peaking in February 2020, but has in recent months been ticking higher as inflation readings have perked up. 

Additionally, long positions in copper, corn and lumber have plunged sharply over the past two weeks. This as the yield on the benchmark 10-year note has declined from 1.7% to 1.6% while recent market darlings like initial public offerings and special purpose acquisition companies have fallen out of favor.

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All this suggests that maybe inflation isn’t what investors should be worrying about, according to David Rosenberg, chief economist strategist at Toronto-based Rosenberg Research. 

"Speculative frenzies end in a deflationary bust," he warned.

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