Market Commentary: Hedging against inflation | Previous interest rate hike cycles

25 March 2022
Stephanie Leung
CIO Office

Watch Freddy Lim, co-founder and CIO, Philipp Muedder, Head of Financial Planning, and Stephanie Leung, Group Deputy CIO, discuss the latest global events and their potential impact on the markets and on our investment portfolios.

In this episode:

  • How we hedge against inflation in your portfolios [0:55]
  • The S&P 500’s annualised return during 12 rate hike cycles [4:19]
  • How asset allocation ties in with your risk level [10:34]


Philipp | 00:01

Hello and welcome, everyone, to another market commentary from StashAway. With me, of course, the investment team comprising our Chief Investment Officer, Freddy Lim. Hey, Freddy.

Freddy | 00:11

Hey, Phillip. Good to see you.

Philipp | 00:13

And our Deputy Chief Investment Officer, Stephanie. Hey, Stephanie, how are you doing?

Stephanie | 00:18

I'm good, thank you.

Philipp | 00:18

It's good to see you. It's been two weeks, it's been the usual turbulence as we've done this now for 2 years, right? There's always something to talk about and obviously, the last time we spoke, we were in like at the end of Week 1, beginning of Week 2 of the Ukrainian war situation. We were also doing this recording 2 weeks ago on the day the Federal Reserve was going to decide on their rate hikes. So we do want to kind of recap a little bit of what has happened since then. And I think, Freddy, maybe you want to give a little bit more comment on these sanctions that are still being; even yesterday there were new sanctions being rolled out. What's the impact so far? And how do you kind of put that situation and sanctions into perspective?

Freddy | 01:13

Firstly, the war is far from over. It turns out the Ukrainian were a lot more resilient in the resistance of the Russian invasion and they got a lot of help with funding and ammunition from the West. So this is going to drag on and we'll have a certain knock-on effect on oil prices. But the sanction hasn't really officially come in. Although a lot of soft sanctions have already happened, you know, around the world, companies were afraid to even take on backdoor channel commodities from Russia, even though it's at a discount because of the fear of sanctions. So you may argue that the sanctions have already started or it hasn't officially started, but it's not going to go away just because the war is over, it's going to stay there for a long time, it's going to be there to instigate regime change, perhaps, or even a certain agreement has to be reached before sanctions will be lifted. So, our base case scenario is, this is going to add to inflation momentum. We will continue to very closely monitor the effectiveness of our inflation hedges in our portfolios. Their valuations versus the inflation level to gauge whether they're going to keep being effective. So very closely watching that in our portfolios in terms of the signals that we get, we do monitor that closely.

Philipp | 02:40

Freddy, you're talking about inflation, right? Just a quick question that I actually have as well - but I think a lot of customers will probably ask themselves that as well, if they're not financial professionals - what in our portfolio do you consider inflation hedges? If you need to single out a few items that we use to do that.

Freddy | 03:01

It's interesting because we have a bunch of traditional ones and double-hatting ones. So on the traditional front we have Gold - that's a classic one. We have inflation-linked government bonds, which is very nice because the coupon gets reset higher with the CPI index, but if the CPI index stays there. It behaves like a safe government bond so it double-hats as a protective asset and an inflation hedge. So we love double-hatting and then we have Australian equities and Canadian equities that provide the currency exposure itself is like a safe haven hat, but it also has this growth component because they're equities - that's for the commodity countries, they benefit from inflation. So their currency moves along with it. For example, like the Australian Dollars. In the case of Japanese equities, which you have some as well for some of the portfolios, they double-hat a safe haven currency and equities. So there's a lot of double-hatting in the portfolio balancing between multiple risk dimensions. That's essentially the summary.

Philipp | 04:04

Oh great. I like that overview Freddy because I think a lot of listeners don't really understand that and we're going to get into it a little bit later - into the benefits of asset allocation again. But I think that already shows, you know, why as allocation is very, very important. So Stephanie, moving on then from the sanctions side of things, right? The Federal Reserve gave an update - maybe you want to give that update and talk a little bit about the rate hike cycle in general, like what you've been looking at from a historical perspective on how that usually plays out?

Stephanie | 04:36

Yeah. So the Fed actually did a historical rate hike, so it started the rate hike last week by raising interest rates by 25 basis points. Now, of course, even before the Fed started rate hiking, the market has been pricing in quite aggressively rate hikes for this year. And before the Fed meeting, the market was already pricing in by the end of the year around 2%. And what we learned from the Fed last week was that they are ready to increase the pace of rate hikes if inflation numbers stay elevated. So Powell actually was quite hawkish and relatively hawkish compared to market expectations. The equity market reaction or risky asset reaction was actually quite good for the Fed meeting, which may surprise some people. But if you look at the historical precedence of how the equities market performed during previous rate hike cycles, we looked at 12 of them, only 11 out of 12 of those episodes - equities actually had positive annualised returns during the rate hike cycle. And on average, the S&P actually returned around 9.4% during those cycles. There was only one exception, which was in the 70's. Now, of course, a lot of people are drawing parallels of the situation right now with the 70's, because if you remember, during that time, oil prices also went up a lot due to supply constraint and geopolitical conflicts and wars. So right now of course, as Freddy mentioned, we're going through the Ukraine-Russia war. And that drove up oil prices and other commodity prices. So a lot of people are drawing a parallel to that stagflation period. And if you look at Google search for example, the search rate for stagflation actually went up quite significantly over the past few weeks. However, there are a few differences. I think the most dramatic difference is the US Dollar. So at the beginning of the 70's period, actually in '71, the US Dollar was depegged from gold and that caused a hyperinflation in the US because obviously, for example, oil is priced in US Dollars. So when the US dollar actually went down a lot, I mean oil prices also went up. And if you look at the US Dollar versus Japanese Yen or the German currency back at the time, actually the US Dollar depreciated significantly during that period. And I think given today's kind of environment, it's unlikely that we will see such significant and fast depreciation of the US Dollar in such a short period of time. So it's quite different from the 70's situation.

Philipp | 07:19

Can I ask you both a question on that? Because I think it's very interesting that you just mentioned, you know, that oil usually is priced in US Dollars, right? We're seeing now this week and it also was in the news late last week - I read it a couple in a couple of different places - is that China is trying to do a deal where they can pay the Saudi Arabian government in Yuan for oil, right? Which is de facto an agreement actually with the US that they should always be priced in US Dollars, right? And then the same thing I was reading today in the European news is that Russia is now asking the European governments to pay in Rubles for their natural gas. So this is really interesting because obviously they're trying to avoid the sanctions because they can't be paid in US Dollars or the US Dollars will always be frozen. So Freddy and Stephanie, are these really big events that are game changing or do you see this just as like a weird short-term thing?

Freddy | 08:21

Yes. I think, Philipp, this is really the crux of the entire issue because it tells you what sanctions really mean or even secondary sanctions means - in a sense that the Russian Central Bank was preparing for this for 9 years, accumulated $680+ billion of FX reserve, and at least half of it got frozen because of sanctions. They didn't expect that to happen because it's in US Dollars. And so there's a fight for derisking by nations. So I think this is huge because assets can be frozen with sanctions or secondary sanctions - that's the message here. And risk management of portfolios need to consider that. If you're investing in certain countries, you need to start managing sanctions risk - think about where you are actually.

Philipp | 09:17

Yeah. No, I agree. This is crazy. Yeah, I just wanted to talk about it because you mentioned this Stephanie just now. And I've been reading a lot about it too and have been trying to do some research on it because it's a very interesting topic because like I said, Saudi Arabia had this deal also with the US actually, right? Or like the Gulf countries with - to be always priced in US Dollars. Now China goes in, Xi Jinping flies to - now I think he's meeting soon in Saudi Arabia or did the meeting already a few days ago, right? So it's very interesting where everyone is trying to position themselves now, right?

Stephanie | 09:50

Yeah. But I mean, the international oil market is very, very complex, right? For example, I think the ask from Putin to price everything in Rubles is going to be very, very difficult to execute because, I mean, all these gas companies basically need to break their contracts. So the Ruble, of course, rebounded quite significantly afterwards. So it's sort of like a, I guess, a very desperate measure by Putin to try to just kind of play against the European threat of sanctions.

Philipp | 10:26

No. Thanks both for your input on this, because I thought it was just very interesting. And I think some readers will have read those headlines as well. So last but not least, I think, Freddy, you already kind of touched on this earlier when we went through the different hedging ETFs that you can use for hedging and why it's important to do so. But you've also seen now, obviously with rate hikes, usually bonds, especially on the shorter scale, have been selling off, right? Which makes perfect sense, right? Now obviously, a lot of people are asking, should I just be all equities, right? Should I get rid of my bonds and take advantage of hopefully rising equity prices over time? Where do you stand on this and explain maybe a little bit about why asset allocation is still important to have a balanced portfolio?

Freddy | 11:14

I think the concept of asset allocation is like a musical chair, right? Sometimes when the music stops, you know, the music will stop many times to play the game and not every line item will make money at any point in time. But you still need the assets to rotate into because for example, what if the rate hikes were so massive that we had a slowdown in growth and the bond side started moving again the other way? They're taking turns to be the next one to sit on the chair when the music stops. So as asset allocators, you are dollar cost averaging for the long term, but for every line item, sometimes some of the line items may not make money today, but they may tomorrow. So over time, they all start compounding into a better future. But the overall effect is to achieve the risk level that you have targeted. If you're 100% equities, simply because of the rate hike situation. But my question to ourselves is, is my risk level as high as the stock market? 100% of the stock markets, that StashAway Risk Index for a portfolio that's entirely consists of stocks would be at least maybe 40% onwards, right? Is that your risk level? If it's not, you still need inflation-linked bonds, you need some commodities, you need some fixed income, although today they may not actually do so well into the hike, right? And also it's hard to predict because things do change very fast. These 2 days have already shown that - 2 days ago the rude awakening by the Fed rhetoric caused a bond route that quickly stabilised yesterday and things actually started doing better and equities did the other way. So the day-to-day should not be the guide to your long-term allocation. So asset allocation is about putting pieces in different parts of the chessboard or musical chairs. They all take turns over time to compound, I think, and with the combined effect of getting you your combined risk level to target. Back to you, Phillipp.

Philipp | 13:20

Oh, thank you so much, Freddy. And I think we can wrap it up there. So basically we do have a few nice upcoming events, so for everyone to attend. So in Singapore, Malaysia, Hong Kong, Mena, and Thailand - in all of our markets, you can join us in our cross collaborative Market Outlook with UBS. That's on Tuesday, the 29th of March. That's 3pm in the MENA region, 6 pm in Thailand and 7pm in Singapore, Malaysia, and Hong Kong. So if you want to join that, as always, the links are in the show notes below and you can always find them on our website and on all of our social channels as well. And then separately in Malaysia, we have a couple of events coming up. One of them is How to Invest (The Right Way) with ETFs. So if you want to learn more about what Freddy was just talking about in terms of asset allocation and what ETFs are. That's on Wednesday, the 30th of March, 6pm, Malaysia local time, and another one on the 6th of April. A follow up to this is How to Plan for Your Retirement. That's at 6 pm on the 6th of April. Again, links are in the show notes below. And then for MENA, we have an event that's called Financial Planning and Investing for Women 6pm MENA local time, 30th of March. Please feel free to join us and we're looking forward to having you again here in a couple of weeks for our market commentary. Until then, I wish everyone a great rest of the week. Bye-bye.

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