Thompson explained that ongoing inflation always drives bond yields up in lockstep as investors seek to offset the loss of purchasing power. Yields have risen steadily since last August, and since bond yields and prices are counter-correlated, bond prices have fallen, which has weighed somewhat on bond portfolios.
She stated, “If monetary policy is tightened, the stock market is likely to have a ‘taper tantrum’ that will recede or perhaps even correct as investors digest a new era of quantitative easing (i.e. bond exit) purchases by the central banks) as a prelude to an increase in key interest rates from their current level of close to zero.
“Higher interest rates mean rising borrowing costs and lower returns, the expectation of which leads investors to price stocks down – at least temporarily.”
So what can consultants do to protect portfolios in this environment? Instead of changes in wholesale, a more differentiated reallocation within an already diversified portfolio is recommended by removing your holdings of companies and sectors that are likely to decline during a period of inflation and focusing on sectors that are more likely to be winners, especially stocks that are benefit from economic growth.
Thompson has advised clients not to shift their portfolio focus to purely “defensive” types of holdings. That means looking at more cyclical sectors like materials, industrials, and consumer discretionary, rather than overweighting areas like consumer staples, utilities, and technology that are typically mandated in low interest rate environments.