Business Daily (Nairobi)
Natsuko Waki
5 June 2008
As inflation rears its head, some analysts are advising investors to seek shelter in emerging economies, stocks linked to scarce commodities and currencies of central banks with proven anti-inflation records.
Inflation has all but replaced the credit crisis as the biggest investor obsession as record oil prices and other costly raw materials boost consumer prices at a time developed economies struggle with a US-led slowdown.
Financial markets have for years seen any sign of inflation as negative for stocks as it was assumed central banks would react promptly by hiking interest rates - hitting economic activity. Bonds also tended to suffer from the prospect of higher interest rates.
Toxic duo
However, this time around, investors are being forced to think beyond the usual asset allocation framework as the toxic duo of rising prices and slowing growth in developed economies tie the hands of major central banks.
And so not all stocks and bonds are to be avoided.
Emerging markets, especially those which have their economies closely linked to a weak dollar, are among trades which would benefit from a globally inflationary environment.
"Let's get in the right side of inflation," said Mark Tinker, fund manager at UK-based fund AXA Framlington. "We have stagflation in the West and inflation in Asia. We want exposure to the inflation sales line, not the inflation cost line."
Tinker says banks in Asia and the Middle East benefit from inflation because their essential raw material - money - is cheap since their currencies are mostly pegged to the dollar.
AXA also likes stocks with energy and scarce resources, oil services and the "Guns and Butter" sector - defence firms which produce civilian goods. Guns and Butter firms include General Dynamics which makes Abrams tanks, Stryker fighting vehicles and Gulfstream luxury jets.
Lex Hoogduin, chief economist at Dutch asset manager Robeco, says the theme of scarcity, not asset classes, is the framework investors should be focusing on when it comes to protecting their portfolio.
"Investors should consider protecting their portfolio by investing in those markets with the scarcity theme - think about where scarcity is - in food, energy and water," he said.
And emerging market commodity producers rank high under this theme.
"Companies in resource-rich Middle East and Russia ... offer excellent protection against the risks of inflation to investors," said Percival Stanion, head of the Multi-Asset Group at Barings Asset Management.
"As does Latin America thanks to the favourable environment there for the production of food to meet the world's growing demand."
In other equity sectors, Credit Suisse prefers utilities given their consumer inflation-adjusted pricing, as well as underleveraged banks in underleveraged countries such as Greece due to their positive correlations with interest rate expectations.
Since the start of the year, the European utilities sector has fared better than the broader regional stock index. The utilities sector fell 8.7 per cent since January, compared with the broader index's fall of 12 per cent.
Looking around the world in search of inflation-proof investment, currencies and fixed income of economies with central banks that have strong inflation credentials also seem to offer a good deal.
Morgan Stanley's data going back to the 1970s shows the euro - and its synthetic measure prior to 1999 - and the Swiss franc consistently gave positive returns during rising inflationary environments thanks largely to the anti-inflation stance of the Bundesbank, the European Central Bank and the Swiss National Bank.
Lehman Brothers have identified Israeli bonds as meeting the inflation-proof criteria.
Appreciating currencies
"A core theme in our global debt asset allocation remains overweight countries with actively inflation-fighting central banks as well as countries with appreciating currencies to deflect domestic price pressures," Lehman said in a note to clients.
"Israel qualifies on both accounts."
According to Lehman, the market value weighted coupon of eight Israeli local currency bonds with an outstanding amount of 78.91 billion shekels ($24.23 billion) is 6.69 per cent, exceeding its Global Treasury Index average of 3.76 per cent.
Duration is also lower at 4.93 years versus the Global Index's 6.00 years. Real yields based on a five-year moving average of inflation command the average rate of 4.08 per cent versus 0.56 per cent for the US Treasury Index.
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