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Three ways to protect against inflation in 2022

Inflation was the story of the year in 2021, and it will likely continue to dominate the debate in 2022.

Tremendous demand for goods and labor during the pandemic has led to the fastest pace of consumer price inflation and wage inflation since the early 1990s. We do think inflation will moderate due to increased labor supply as the pandemic fades, and as spending shifts toward services and away from goods. It should not, in the end, pose a risk to our base case view—which anticipates a far more vibrant cycle in the 2020s than we saw in the 2010s.

But we do still expect a relatively brisk pace of increases for both prices and wages. We think investors can take three approaches to navigate this environment.

1.  Look to real estate for inflation protection

Real estate investors typically benefit from a natural hedge against inflation because leases periodically reset higher. What’s more, we see powerful structural tailwinds to the residential and industrial real estate sectors. Housing is in short supply in the United States following chronic underbuilding (relative to trend) after the global financial crisis. Workers are enjoying strong demand for their labor, and wages are rising, which should keep housing affordable even as home prices appreciate. Remote-work-enabled migration is also creating opportunities.

In the industrial sector, the continued shift toward e-commerce will necessitate more warehouses, storage and logistics globally. Problems in the global supply chain that became glaringly evident in 2021 highlight the need for more investment. We also see growing demand for research facilities for life sciences. While we prefer to invest in real estate through private markets, publicly traded real estate investment trusts (REITs) also tend to perform well in high-inflation periods relative to other equity sectors. In short, real estate is our preferred way to play a higher-inflation environment in portfolios.

2.  Rely on equities, especially cyclical ones, to drive capital appreciation.

While economists debate the intricacies of inflation, the basic principles of the current episode seem clear: Inflation is being driven by strong demand and economic growth. Equities tend to do well in inflationary environments because corporate earnings are also strong. More specifically, we believe equities of companies that are more directly tied to economic activity and interest rates would likely outperform. The relative valuations of bank stocks, for example, are historically tied to inflation expectations. Companies with pricing power in cyclical industries such as industrials and materials could see robust revenue growth. On the other hand, the stocks that tend to do best when growth and inflation are scarce (think the digital economy) could be at more risk. You should ensure proper balance between the two groups, in our view, and also expect a challenging environment for fixed income portfolios as rates continue to rise.

3.  Avoid excess cash, and consider borrowing.

80% of the assets we assess as part of our Long-Term Capital Market Assumptions have a higher expected return than inflation. The easiest way to defend purchasing power is to invest excess cash in a portfolio that fits your goals and time horizon. In the current environment, borrowing could also be prudent. Interest rates are still low, especially relative to inflation. A mortgage is a simple way to benefit from a strong housing market. If the Federal Reserve reacts to higher inflation by raising rates, it could make borrowing costs less attractive.

Key takeaways

Higher inflation may remain into 2022, but it need not be a cause for concern. Investors can build a portfolio that acknowledges and seeks to mitigate inflation risks. Relying on equities relative to fixed income, and focusing on cyclical sectors and real estate could prove to be effective approaches, while excess cash seems unattractive. Meanwhile, borrowing and addressing existing liabilities while policy interest rates are still low may be advisable.

Your J.P. Morgan team can offer you more insights into how this current environment is shaping risk and return potential, in the context of your specific situation and goals. 




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