While global shortages of everything from wheat to semiconductors have been blamed by many for causing historically high inflation, FlexShares Senior Investment Strategist Chris Huemmer points his finger at another problem: demand.
“I think demand is also what's driving inflation beyond the cheap money and the supply chains,” he told ETF.com’s Exchange Traded Fridays Podcast hosts Heather Bell and Sumit Roy last week. Still, he said continuing wage growth and hiring are also fueling inflation.
Inflation and interest rates dominated Huemmer’s comments. He pointed out that if inflation disappeared for the rest of the year, the U.S. would still record annual price increases above 7%.
Inflation is also causing stocks and bonds to drop together, said Huemmer.
“This is prototypical of what we see in these types of environments, and it’s the reason we talk about real assets or alternatives as being key pieces of a portfolio today. This inflationary environment is definitely something that is a challenge for investors,” he added.
FlexShares, the ETF arm of Northern Trust, manages $19.4 billion across 32 ETFs, according to ETF.com data.
Huemmer is dismissive of claims that inflation would disappear with the resolution of supply chain bottlenecks. While he sees global supplies and procurement as contributing to higher prices, he credits other factors more: the Fed’s quantitative easing, the pandemic stimulus and the resilience of demand.
With the interest rate expected to top out at 4.5%-4.75% next year, Huemmer says the Fed is communicating “very strongly” its thoughts on inflation and interest rates.
“As the old adage says, ‘Don't fight the Fed.’ Understand what they're trying to accomplish and adjust accordingly,” he advised.
Energy, Agriculture, Infrastructure
With inflation remaining high and recession looming, Huemmer believes energy demand will stay strong as winter approaches, along with agricultural products, due to Russia’s and Ukraine’s vast contributions to the global grains market.
Infrastructure is another investment category he sees as compelling in an inflationary environment with a recession looming.
“It's an asset class that tends to do well late in the economic cycle, as it tends to be more inelastic in demand, meaning that in both booming economies and bust economies, people need access to mission-critical things like energy, potable water, waste management, transportation, even things like information,” he explained.
Huemmer says low volatility and dividend-paying strategies are also attractive right now.
“One alternative to moving out of equities today would be to change your portfolio and move from a beta or market strategy and look at low volatility strategies. That's something that's been very compelling—to reduce your risk, not by moving out of risk assets, but to move towards low volatility,” he said, pointing out there have been an increasing number of spikes in volatility levels, which are close to levels during the worst of the pandemic.
Dividend-paying strategies make sense, Huemmer said, because equity returns will likely be below the long-term average for the next five years.
“With that in mind, strategies that are more focused on total return and not just capital appreciation are going to come more into vogue. Dividend strategies, where you're collecting coupons as well as participating in potential upside capture, is also very compelling today,” he noted.
Finally, Huemmer thinks investors should consider high-yield credit, noting that balance sheets in the junk space are looking stronger than they have in the past and the category has delivered equitylike returns with less volatility.
“It’s pretty attractive from a Sharpe ratio perspective,” he added. “The view is that they’ll be more resilient in this current market environment.”
Contact Heather Bell at [email protected]