Bottom line up top

• The sticker shock for groceries and rent could be with us for a while. Prices for these bare necessities climbed sharply over the past year (Figure 1), helping push headline inflation to decades-high levels:
  • In May, the CPI food component marked its first 12-month increase of 10% or more since March 1981, propelled by labor and ingredient shortages in food supply chains, higher energy and transportation costs, and surging prices for wheat and other agricultural commodities.
  • Rents have spiked as scant supply has met surging demand, driven in part by would-be homebuyers priced out of the housing market thanks to a similar supply crunch, soaring residential construction costs and higher mortgage rates. The shelter component of CPI, which reflects rental prices, rose more than 5% compared to May 2021 — the largest year-over-year jump since February 1991.
• If these trends upend spending patterns, consumer contributions to economic growth could weaken. So far, consumers have maintained spending, even as food and shelter claim a bigger share of their budgets. To do this, they’ve saved less and borrowed more. Whether this is sustainable remains to be seen, but last week’s negative surprise in retail sales for May (and downward revision for April) could signal potential cracks in the strong-consumer narrative. We’ll learn more when personal consumption expenditures — more comprehensive than retail sales — are released at the end of June.
• Hedging inflation in portfolios has become more challenging. Asset classes traditionally seen as go-to investments during inflationary periods, such as TIPs, generally haven’t been effective this year. We’re taking a closer look at other potential opportunities within fixed income, equities and real assets that we believe can offer some inflation protection and may warrant an allocation.

“As inflation in bare necessities like food and shelter runs high, consumers may be forced to cut back other spending. We’re watching this trend closely.”

Portfolio considerations

Combating inflation is tricky when the Fed is tightening. Increasing costs of essentials like food, transportation and shelter will continue to pressure global central banks to act boldly to restore price stability. As of Friday’s close, futures are now implying a fed funds rate just shy of 4% in mid-2023, up from 3% only two weeks ago. This rapid change in expectations has been felt across equities, credit and rates alike, reminding allocators how quickly asset correlations can rise during severe, liquidity-driven selloffs.

What to do now? When liquidity is scarce, those who are in a position to put cash to work can find themselves well compensated. Consider U.S. high yield bonds, for example. While not a typical inflation hedge, investors with long time horizons and high single-digit return targets might find starting yields north of 8% for the broad index and 7% on the BB rated segment attractive. Within equities, we have a high conviction in infrastructure, which includes many companies that are better positioned to pass increased operating costs through to end users.

Historically speaking, strategic allocations should be designed to generate returns that over time will outpace long-term inflation. There’s no greater threat to achieving this objective than severe portfolio drawdowns that deplete one’s capital base, given that it takes an 10% return to recover from a 9% drawdown, and a 100% return to recover from a 50% drawdown. That means owning broad equities (which outpace inflation over the long term, but can struggle in high-inflation periods) alongside productive, cash-flow-generating real assets. While no two macro environments are exactly alike, Figure 2 segments historic returns into four different inflation regimes. Although commodities, specifically crude oil futures, might be the most direct inflation hedge, they can also be volatile and prone to downside swings in more disinflationary environments.

“Commodities often shine during periods of high inflation, but over the long term tend to introduce significant portfolio volatility.”

Nuveen’s Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.

Regular meetings of the GIC lead to published outlooks that offer:

• macro and asset class views that gain consensus among our investors
• insights from thematic “deep dive” discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
• guidance on how to turn our insights into action via regular commentary and communications