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For today’s Soundbites, we discuss the market implications of inflation with Hadiza Djataou, vice president and senior investment director with the fixed-income team at Mackenzie Investments.

She talks about preferred investment products in inflationary times and effective hedges against inflation… and we started by asking where she thinks inflation is headed as we close out the year.

Hadiza Djataou (HD): We believe that inflation is going to be stubborn and is going to stick around for at least until the middle of next year. We’ve seen that inflation has been mainly fed by supply bottlenecks, some imbalances between the demand and the supply, especially in some sectors like the auto sector where the chip shortage has created just a backlog that car makers are not able to address. And we also feel that in specific other sectors, like the real-estate sector, we’ve seen rent prices going significantly up, we see also on the job market some wage inflation in specific sectors. And all those elements lead us to believe that inflation is going to be higher than the inflation we experienced before Covid.

Preferred investment products in inflationary environments.

HD: Healthy inflation is an inflation that is driven by demand. And there’s a couple of investment products that do well. You have, first of all, stocks, because if demand is rising, corporates are healthy, they have healthy balance sheets, they have higher earnings, and as a result, their stock prices tend to appreciate. In the fixed-income spectrum, you will have corporate debt, for instance, that can benefit from an inflationary environment. Lastly, when you look at safer assets in the fixed-income space, treasury inflation protected [securities —TIPS] typically will also benefit from a rising inflationary environment just because they offer a coupon that is indexed on that inflation. Other direct inflation hedges are commodities as a whole. Gold, lumber, all those commodity prices have been rising significantly. Bitcoin is also seen as an inflation-protected asset. There isn’t enough historical data to be able to really confirm that they actually provide a hedge against inflation. But if the market collectively believes that Bitcoin is going to protect them from inflation, well, there is a strong correlation when inflation expectation is rising, we see Bitcoin price rising again.

What bond classes she likes right now.

HD: When we look at our asset allocation across the fixed-income spectrum, first of all we are significantly underweight government bonds, because we expect rates to rise into 2022. The two main compelling reasons why we expect rising rates is the growth outlook and inflation outlook that we just discussed. In an environment where we expect growth in the U.S. to be around 3%, pretty much the same in Canada, it is hard to believe that the U.S. 10-year treasuries can stay at 1.5%, where it is today. That inconsistency at some point is going to lead to a rise in rates. The second reason is that, yes, the market is already pricing [for] a rate hike, for sure, but we think that the market is not pricing, notably in the U.S., those rate hikes to the extent that we expect them. On the other side of the spectrum, we love corporate debt and we’ve been expressing our active risk positioning in high yield, and also in investment grade. One of the key strengths of our team is to play that corporate space both in public debt market but also on private debt, where we’ve been adding some significant exposure throughout 2022.

And finally, what’s the key message for fixed-income investors?

HD: I believe that we are all fixed-income investors to some extent through our different pension programs, RRSPs, etc. And one of the key messages to deliver is diversification is absolutely paramount. The traditional 60:40 has worked extremely well over the past several years because there was a lot of balance between risk assets and safe assets. And while fixed income are challenging, there’s still a strong case to be made to own core fixed-income assets in a very well-built portfolio.

Well, those are today’s Soundbites, brought to by Investment Executive and powered by Canada Life. Our thanks again to Hadiza Djataou of Mackenzie Investments.

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