Low coupon rates are making bonds less likely to protect investors from inflation, but individuals considering moving to equities should do so cautiously, says James Dutkiewicz, vice president and senior portfolio manager, Sentry Investments.
“Equities as a hedge against inflation does work,” said Dutkiewicz Wednesday at the Retirement Coaching Conference for Financial Advisors in Toronto, “but they work with some caveats.”
For equities to work properly as a hedge, said Dutkiewicz, inflation must be moderate, “well telegraphed” and be demand-pull inflation.
In the first case, inflation needs to be moderate, meaning single digits, because in instances where it is volatile, such as in the 1970s said Dutkiewicz, equities are not a good option. “Equities get crushed,” he said.
The second indicator that equities can be an appropriate asset class to hedge against inflation is when the inflation appears stable or “well telegraphed.” For example, Dutkiewicz describes inflation as being “well telegraphed” when it increases in slow increments each year such as 1% to 1.5% to 2% over a three-year period.
Finally, in order for equities to work as a hedge against inflation, said Dutkiewicz, inflation must be demand-pull as opposed to cost-push inflation.
In the case of cost-push inflation, it is caused by a supply shortage, such as in energy or food, which causes prices in one area to skyrocket. Cost-push inflation “acts like a tax” on people’s discretionary income and as a result companies cannot pass additional costs on to consumers, said Dutkiewicz, in that case equities will not work as a hedge.
Demand-pull inflation occurs, said Dutkiewicz, when the economy is growing strongly and incomes increase, which means businesses can pass on some in-put costs and increase their margins. “Because demand is rising, now we’re rolling,” he said. “When you get demand-pulled inflation that is a great environment for equities to act as an inflation hedge.”