Source: FT Chinese Author: Xia Chun, Chief Economist of Noah Holdings Group; Cheng Yaman, Vice President of Noah International Research Department This article only represents the author's own views. Editor: Feng Tao [email protected]
Image credit: Getty Images In the statistics of global asset prices during the Spring Festival, Bitcoin and gold ranked first and last respectively, and the reason behind this is related to inflation. How should investors hedge against the impact of inflation on asset prices? Text丨Xia Chun, Cheng Yaman
On February 17, the first day of work after the Spring Festival, a chart showing the changes in global asset prices during the Spring Festival attracted everyone's attention. Bitcoin and gold ranked first and last among more than 50 assets, respectively.
In fact, Bitcoin continued its strong performance since the end of January, breaking through the $50,000 mark for the first time on February 16, and has risen by more than 80% this year. However, gold has maintained its downward trend during the same period, falling 10% and breaking through the low point at the end of 2020. Recently, long-term U.S. Treasury yields have risen rapidly, and stocks and most commodities have maintained their growth momentum. Behind these eye-catching price changes are all related to changes in inflation risks.
This article will analyze the current market disagreement on inflation risk, judge the future short-term and medium-term trend of inflation, and its impact on asset prices. Readers who are concerned about why gold fell and Bitcoin soared under rising inflation expectations can jump directly to the last section of the article. The separation of expected and actual inflation
In terms of data, there has been a significant divergence between recent inflation expectations and actual inflation levels. The inflation expectations implied by market pricing are rising rapidly: the 10-year US breakeven inflation rate, a common indicator for measuring market inflation expectations, has recently risen to above 2.2%, reaching a new high since mid-2014. This indicator reflects that investors expect average annual inflation to exceed 2.2% in the next 10 years, which is above the Fed's 2% inflation target.
However, actual inflation remains low under the pressure of the epidemic. The annual average of the personal consumption expenditures deflator (PCE), which is closely tracked by the Federal Reserve, fell from 2.1% in 2018 and 1.5% in 2019 to 1.3% in 2020. In January, the core consumer price index (CPI), excluding energy and food, has been zero growth for two consecutive months, and the year-on-year growth rate is only 1.4% compared with the same period last year.
The investment community has generally begun to worry that rising inflation will hit the market. Summers, the former US Treasury Secretary who has a huge influence in the investment community, believes that Biden’s stimulus plan may trigger inflationary pressure that has not been experienced in a generation, which will in turn affect the value of the US dollar and financial stability. His views are the same as those of many investment giants.
However, the attitude of the policy community is obviously different. Federal Reserve Chairman Powell opposed the above statement, and Treasury Secretary Yellen also said that inflation is not the main risk at present, and she fully supports Biden's stimulus plan to restore the economy and employment.
Amid data differentiation and divergent views, investors are more sensitive and nervous about potential high inflation, which is closely related to the shadow left by the great inflation in the United States in the 1970s and 1980s. The economy fell into stagflation against the backdrop of the oil crisis and the decoupling of the dollar from gold. In order to combat inflation, then-Fed Chairman Volcker started a cycle of interest rate hikes in 1977, which triggered an economic recession in the early 1980s, with the unemployment rate rising sharply to over 10%.
However, surprisingly, in the following 30 years, due to the combined effects of factors such as the aging population, the rise of emerging markets driving globalization, the widening gap between the rich and the poor, and the dominance of the economy by technology giants, excessive savings caused a decline in total demand and low growth became the norm. Inflationary pressures have basically disappeared in developed countries, and the "Phillips curve" that describes the relationship between inflation and unemployment has also failed.
Possible short-term and medium- to long-term development paths of inflation
At present, the main factors for the rapid rise in inflation expectations are as follows:
First, the fiscal stimulus plan launched in response to the epidemic, especially the transfer payments to the household sector, will directly increase private household income, boost consumption and inflation. Unlike the adjustment mechanism of monetary policy, fiscal subsidies flow directly into the real economy, and the current proportion of direct transfer payments to residents' disposable income has reached a new high, supporting the overall income of American residents during the epidemic.
Data released on Wednesday showed that U.S. retail sales in January not only broke out of the contraction range of the past four months, but also increased sharply by 5.3%, mainly driven by the $600 relief checks per person that boosted consumption.
Furthermore, except for the special case of stagflation, inflation is more likely to occur during rapid economic growth. This year, US economic activities will accelerate their recovery from the shadow of the epidemic. Some people believe that Biden’s $190 million stimulus plan has exceeded the scale needed to fill the current economic gap, whether measured by the output gap or the household income gap, and may cause economic overheating.
In addition, loose monetary policy will continue for some time. In particular, the new framework launched by the Federal Reserve last year targets average inflation and allows inflation to temporarily exceed 2% without taking action too quickly, which means that the tolerance for inflation will be higher.
In short, this combination of policy environment and economic situation is likely to push up prices. There are already some signs of rising inflation, including the unexpected increase in labor costs in the fourth quarter of last year and the industrial production price index (PPI) in January this year.
Coupled with the low base effect, we expect that inflation in the United States may rise rapidly in the coming months, especially from the second quarter to the middle of the year, when the year-on-year inflation growth rate may exceed 3 and approach 4. Consumer categories that were hit hard last year, such as aviation, hotels, and clothing, will recover quickly after the epidemic improves this year, and prices are expected to rise rapidly.
However, this surge in inflation is more likely to be a short-term phenomenon. As fiscal stimulus is withdrawn and economic growth returns to normal, inflation will face certain downward pressure and return to around 2%.
The reason why the US inflation is unlikely to get out of control after it surges is, first of all, that the unemployment rate will remain high this year. Currently, the United States still has about 10 million job vacancies compared to before the epidemic, and the bargaining power of cheap labor for wage increases is still low.
Furthermore, the status of the US dollar as a reserve currency and the main means of international payment remains difficult to shake, and the inflationary pressure caused by the over-issuance of US dollars can still be largely shared by the world.
In the medium and long term, the U.S. inflation center will be higher than in the past 20 years. The reason is that the multiple factors that suppress inflation are loosening or changing.
For example, during the period of accelerated globalization, cheap labor from China and other places significantly lowered U.S. inflation. After China joined the WTO, the CPI of core commodities in the United States experienced a sharp decline. At present, the process of globalization is hindered, and anti-globalization and supply chain disturbances are still continuing. Both Trump and Biden are emphasizing "Made in the USA", which may raise costs and prices from the supply side.
Furthermore, the widening gap between the rich and the poor was once an important factor in suppressing inflation, but in recent years, the public dissatisfaction and rise of populism caused by this issue have forced the ruling party to deal with this problem. Once Biden starts the tax increase cycle, the proportion of the middle class is expected to rise, and the consumption capacity of the household sector will also increase.
Moreover, the combination of low growth and low interest rate conditions and the impact of the epidemic has caused fiscal policy to change from subordinate to dominant, making it more likely to push up inflation.
Our core view can be summarized as follows: in the future, inflation will form an N-shaped trend, with a short-term peak and then a decline, and an increase in the medium- and long-term center.
How to hedge the impact of inflation on asset prices?
So, if inflation shows an N-shaped trend, what impact will it have on various assets? How should investors respond in advance?
The bond market is very sensitive to changes in inflation expectations and bears the brunt of the impact. After the recent rise in inflation expectations, long-term government bond yields in the United States and Europe have risen across the board, and the yield curve has become steeper. The 10-year US Treasury yield has risen to more than 1.3%, and the 30-year yield has risen above 2%, which continues to be bearish for the bond market. In terms of strategy, it is recommended to shorten the duration, go long on short-term bonds, and go short on long-term bonds. We maintain our view of increasing holdings of inflation-linked bonds. When the inflation risk is greater than the market has digested, it is still attractive.
In terms of exchange rates, the US dollar has rebounded, but this is only one of the factors affecting the price of the US dollar. It does not change our judgment on the medium- and long-term trend of the US dollar. When global growth is high and inflation rises, some emerging market currencies tend to perform better.
Reducing cash holdings and actively investing can help investors better fight the risk of rising inflation. Demand recovery, supply constraints and inflation expectations are expected to jointly drive up commodity prices. Cyclical assets such as industrial metals, energy commodities, natural resources and raw materials, as well as high-dividend assets, will perform better than growth and defensive assets such as technology.
In addition, physical assets such as real estate are also traditional options for combating high inflation. In addition to the current economic growth and financial conditions that are favorable to real estate performance, the US real estate market is also supported by two particularly favorable factors.
First, the U.S. stock market has continued to rise over the past decade, and a large amount of funds will be transferred to the real estate market under the demand for rebalancing allocation. This is in contrast to the fact that Chinese households have shifted incremental funds from real estate to the stock market in the past three years, but the underlying allocation logic is consistent. Last year, U.S. real estate rose significantly, and the epidemic only accelerated this change in allocation demand.
Second, the population aged 30-39 in the United States currently accounts for the largest proportion. More than a decade ago, the bubble in the real estate market burst under the financial crisis, which had a huge negative impact on American families, causing this generation to postpone their demand for home purchases. The home ownership rate in the United States has continued to decline from 69% before the crisis to 64% in 2019.
As this generation enters the stage of marriage and childbirth, the demand for home purchases increases, and the epidemic accelerates this process again, with the home ownership rate in the United States rising to 67% in 2020. Supported by these two factors, we expect this ratio to break the historical high.
Why do Bitcoin and gold move in opposite directions?
In the past, gold has a certain anti-inflation effect. The nominal interest rate remains unchanged while the inflation rises, which means the real interest rate falls. The real interest rate and the precious metal price show convexity, which means that when the real interest rate is at a very low level, a small marginal increase will lead to a higher increase in precious metals. However, gold and other precious metals have not been the best inflation hedging tools in the past. A careful analysis of the data will reveal that in the past 10 years, the trend of gold and inflation expectations is completely opposite.
Although Bitcoin has won investors' attention as a product to combat inflation, its price fluctuates greatly and is not greatly affected by inflation.
Regardless of whether the two can really hedge inflation, why has gold fallen and Bitcoin soared in the past six months? We believe that in addition to some popular views, the most important reason is that the increase in market risk appetite suppresses the rise of gold, which is also the main reason why we started to be bearish on gold in October last year. On the contrary, Bitcoin is the most obvious investment direction after the increase in risk appetite. For investors who prefer risks, the high price volatility of Bitcoin is actually its advantage.
Another important reason is that in the eyes of wealthy people (especially the new rich), compared with gold, which has an investment history of thousands of years, Bitcoin, which was born only 11 years ago, is fresher, more dynamic, and therefore more attractive.
During the Spring Festival, we revisited Harari's "Sapiens: A Brief History of Humankind" and "Homo Deus: A Brief History of Tomorrow", which mentioned that the biggest difference between humans and other animals is that humans can coordinate actions on a large scale driven by "stories" and "beliefs". With the flood of funds, various "stories" have the best environment for dissemination. Musk and Catherine Wood, the most popular male god and goddess of venture capital in the industry and investment circles, have created the miracle of new energy vehicles and Bitcoin, attracted fans around the world, and become the object of capital pursuit. It is just a repetition of history.
A rule of thumb familiar to the investment community is that wealthy people pay more attention to investment assets and topics that are new and exciting. Even if Bitcoin cannot become a currency in the future, as an "electronic work of art", it can still meet the collection needs of wealthy people.
Another rule of thumb in the investment community is that the capital market will continue to cater to the needs of investors. Institutional investors are also becoming more receptive to cryptocurrencies. Mainstream payment institutions, large custodian banks such as BNY Mellon, and asset companies such as BlackRock have also entered the field. Bitcoin-related ETFs have successively obtained regulatory approval in some countries. All of these have provided new "stories" and "beliefs" for the rise of Bitcoin.
In addition, the traditional financial circle often underestimates the important support of the network effect on the value of Bitcoin, that is, as long as the network exists, the value of Bitcoin will be difficult to return to zero, otherwise the core holdings of Internet stocks will also return to zero. In this environment, the recent strong rise of Bitcoin has also diverted the safe-haven buying of gold, putting pressure on the price of gold.
However, we also remind everyone that the U.S. policy community is not very fond of cryptocurrencies such as Bitcoin, and investors need to pay close attention to Yellen and the incoming chairman of the U.S. Securities and Exchange Commission, Gensler, on their regulatory proposals for cryptocurrencies. |
