This article is part of Morningstar's Guide to Alternative Investing; providing everything you need to know about property, commodities, infrastructure and other diversifying assets.
Inflation has hit a two-year high, up to 1.2% in November from 0.9% the previous month. The rise was in line with expectations, as the UK begins to feel the force of falling sterling and rising commodity prices.
Although the figure is still some way off the Government’s 2% target, it is expected that inflation will rise throughout 2017, as the cost of imports and oil pushes up the cost of living. The price of oil fell to $26 a barrel in February, and if it follows historic trends, the price should double of the proceeding 400 days.
Schroder’s multi-asset fund manager Marcus Brookes says that rising inflation is typical of the point in the market cycle which we are currently in – inflationary growth.
“Over the past five years the market has been in a period of dis-inflationary growth,” he said. “We may have been worried about recession but we have actually experienced positive economic growth. Typically developed market equities and real estate assets perform well in this part of the market cycle, which we have seen in the performance of the S&P 500.
“During periods of dis-inflationary growth commodities do not fare well, which has been evidenced by the oil price falling from $140 a barrel to $26 a barrel in February of this year. But now we have shifted into the inflationary growth stage, and those are the type of assets you want to own – emerging markets and commodities.”
Looking at the investments which have outperformed year to date this rings true – those funds and sectors which were the worst performers of 2015 have rebounded in 2016; natural resources, emerging markets and at a stock level miners such as Glencore (GLEN) have more than doubled their share price since the beginning of the year. Gold has also done well this year, although there has been a sell-off in recent weeks.
Inflation Will Continue to Rise
Bronze Rated investor Brookes expects inflation to rise steadily next year and as fuel gets more expensive households will feel the impact. There may be good news in the form of wage inflation too. As the unemployment rate is so low, employers looking to fill roles can no longer rely on recruiting “off the sofa”, but must offer those already in employment a better wage to fill new roles, creating wage inflation.
This will be a welcome event not just for individual households, but potentially for politics too, as evidence suggests that rising income inequality leads to rising political extremism. Brookes points to Brexit, the election of Donald Trump to President of the United States as well as the rise of the 5 Star Movement in Italy and the rise of the Front National in France as signed that political extremism is rising in a number of places across the Western world.
What Does Well Now?
The low yield environment has created clear winners and losers, but with the Federal Reserve poised to raise rates we have already seen classic defensive stocks have stated to sell-off since August, accelerated by the election of Trump. Now that bond-proxies have been knocked off the top spot it is time to invest in more cyclical sectors.
“I expect to go overweight emerging markets in 2017,” said Brookes. “The strong dollar has put pressure on emerging markets but if you see a wobble in the dollar that is the time to buy. Commodities are stabilising and emerging markets are ripe for a rebound.”
Brookes picked Artemis Global Emerging Markets fund to gain exposure to the sector. For developed markets, he said it was time to take a value tilt, picking Investec UK Special Situations and GAM UK Diversified.
