BMO Economics Report: Persistent Inflation Playbook

• Advice for investors given stubbornly high inflation
• Investor strategies include favouring Canadian equities and hard assets, locking in borrowing costs

TORONTO, Nov. 19, 2021 /CNW/ - With inflation on the rise and pressure on interest rates creating more risk, BMO Economics has published a report on how investors can cope.

"We continue to believe that inflation will be more persistent than most initially thought, and that interest rate hikes could come sooner, unfold faster and reach a level that is somewhat higher than expected," said Robert Kavcic, Senior Economist, BMO Capital Markets.

Mr. Kavcic noted that today's environment does not look at all like stagflation. "While most of the focus is on supply-side constraints, the reality is that demand is extremely robust, job markets are tight, and the unemployment rate is falling. That certainly is a 'less-bad' inflationary environment than some past episodes like the 1970s. Rather, periods like post-WWII rebuilding or the 1960s (social and war-time spending along with low unemployment, low interest rates and new technology) are closer parallels."

"At BMO Global Asset Management, we believe inflation will be transitory, but is likely to remain longer than most people are expecting and well into the first half of 2022," said Sadiq S. Adatia, Chief Investment Officer, BMO Global Asset Management. "We want to continue to remain overweight in equities and focus on areas where we see good offsets to higher inflation and interest rates. North American sectors we expect to perform well in this environment include financials and those tied to re-opening, such as energy."

The report suggested several strategies for investors in this environment, including:

• Favour stocks, while choosing carefully. Canadian equities have shown resilience, while dividend yield and dividend growth take on increased importance in a real total return context. Higher-growth/higher-multiple areas of the market tend to struggle as discount rates rise.
• Pick companies with pricing power that are able to pass most wage and cost increases to customers. Firms that face limited competition and sell items with inelastic demand (due to a lack of close substitutes) are likely to preserve capital during periods of rising inflation. Canada has many names with a rich history of dividend increases that fit the bill.
• Real estate has managed to post positive returns through inflationary periods even after accounting for price gains, meaning it has offered good protection. Commercial real estate looks less inflated at this point and should hold up reasonably well with underlying economic conditions still strong, though the office sector faces longer-term challenges from remote working.
• Other hard assets have a role, including traditional inflation hedges such as commodities such as precious metals and gold. While some would characterize cryptocurrencies as a form of digital gold – which might make it a modern-era substitute – they have a limited track record as inflation hedges and could well sell off alongside other assets if interest rates rise too much.
• Buy inflation-protected notes. Treasury inflation-protected securities pay a fixed real rate of return plus a variable return tied to the prevailing inflation rate. The higher is inflation, the larger is the combined payout.
• Diversify geographically. Inflation isn't heating up everywhere. Japan's CPI rate, for example, was virtually zero in September. While its economy would still suffer as a global downturn slams exports, it would stand a better chance than nations with high inflation of avoiding a recession given low interest rates.
• Park some funds in money markets before central banks pull the rate trigger. Though money-market returns are tiny today, they will increase when the Bank of Canada and Fed raise policy rates, expected in the second half of 2022.
• Keep an eye on debt. Rising inflation can be cold comfort for over-extended households if interest rates climb too quickly, straining service costs. For those with already stretched finances and limited wage bargaining power, the safest strategy might be to repay debt if possible, or at least avoid taking on new loans. Consolidating loans in lower-rate products is also a good option.
• Lock in borrowing costs. In a rising inflation and interest rate climate, borrowers can save money and reduce default risk by choosing fixed rates. As one example for mortgages, given our base-case forecast for the Bank of Canada to raise policy rates by 150 basis points starting in mid-2022, and the current 100 basis-points spread between variable and fixed-rate 5-year mortgages, borrowers would save moderately over the five-year period by locking in.

To view the full report, visit: https://economics.bmo.com/en/publications/detail/32530858-7711-4e79-839d-98171e26e6f5/

About BMO Financial Group
Serving customers for 200 years and counting, BMO is a highly diversified financial services provider - the 8th largest bank, by assets, in North America. With total assets of $971 billion as of July 31, 2021, and a team of diverse and highly engaged employees, BMO provides a broad range of personal and commercial banking, wealth management and investment banking products and services to more than 12 million customers and conducts business through three operating groups: Personal and Commercial Banking, BMO Wealth Management and BMO Capital Markets.

Internet: www.bmo.com      Twitter: @BMOMedia

SOURCE BMO Financial Group

For News Media Inquiries: Peter Scott, Toronto, [email protected], [phone]; Colleen Hamilton, Toronto, [email protected], [phone]