Looking in more detail about inflation will help with asset allocation decisions. There is a difference between core and headline inflation. Headline inflation will be impacted by energy costs. Put in the context of today, if inflation is coming through increases in wages the effect on asset prices will be different than an increase in oil, food, and or metals. A commodity shock to inflation should be viewed differently from a wage cost shock. An inflation shock associated with higher energy prices should not be viewed as the same as other inflation shocks. (See "Getting to the Core: Inflation Risks Within and Across Asset Classes".)
The impact of core inflation on stocks is different than headline inflation. Stocks are not sensitive to headline inflation, but there is a strong negative effect from core inflation and a positive beta from energy price increases. The sensitivities to inflation vary highly against different asset classes. The conventional hedges for inflation such as commodities and currencies are less effective against core inflation. The relationship between inflation and asset prices is time varying. Hence, it is difficult to make broad generalization concerning past inflation shocks and current market conditions.
Clearly there has been a pandemic inflation shock and energy costs have risen from the extreme lows of last spring, but the current inflation shock is also driven by an increase in income. The demand for products has increased which has supported firm profit margins. Similarly, this inflation shock based on percentage change is huge, but the level of inflation is still low versus other shocks. Notice that stocks do well even in rising inflation when the level of inflation is still low.
Investors need to be specific about inflation risks in order to make good investment decisions.
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