Here are assets JPMorgan says are vulnerable to commodity-fueled inflation

The record surge in commodities has intensified investor angst that inflation could upend what has been a Goldilocks period for many markets.

Global stocks sold off for a second day Tuesday as a Bloomberg gauge of commodities soared to an all-time high, fanning fears of sustained price rises impacting corporate margins, end demand and monetary policies. Technology stocks and emerging-Asian markets are among those most at risk, while cyclical shares and the assets of energy-exporting nations are seen as possible havens, according to investors.

Fueled by an energy crisis and accompanied by rising bond yields, the commodity rally has also brought the specter of stagflation into the debate on how transitory inflation will prove. That has investors rethinking their conviction on reflation bets and considering how various assets would respond to an environment of higher prices and stagnant growth.

“A stagflation portfolio should be overweight commodities, neutralish in equities and underweight bonds,” wrote JPMorgan Chase & Co. strategists including Marko Kolanovic, in a note to clients Monday. “Instead, an inflation portfolio should be overweight commodities and equities and more aggressively underweight bonds.”

 

The MSCI AC World Index of global shares has continued to drop this month, after posting its worst performance since early 2020 in September. The yield on a Bloomberg gauge of global government bonds has risen almost 20 basis points in two months to 0.80%.

Here are the pressure points and opportunities investors see in global assets:

Equity Pressure

Stock investors were able to brush off concerns about rising inflation earlier this year, in part because earnings estimates were still climbing. But fears that higher prices will eat into margins look to be already hitting profit expectations.

Citigroup’s Global Earnings Revision Index -- a worldwide measure of analyst upgrades minus downgrades of profit expectations -- is plummeting toward negative territory after hitting an all-time high in May. 

 

Richly-priced tech shares could be first in the line of fire, as investors gauge higher inflation will translate into higher yields, calling into question the cohort’s valuation. 

The Nasdaq 100 fell for five of the previous six trading days through Monday. The MSCI Asia Pacific Index lost as much as 1.7% Tuesday in its third straight day of declines, with technology stocks contributing most to the weakness.

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On the flip side, energy and cyclical stocks like financials are well placed to perform in a higher inflationary environment, according to JPMorgan. Stagflation would favor defensive sectors like staples, the strategists added.

Emerging Opportunities

In emerging markets, investors have to balance the inflationary risk to bonds and currencies with the benefit many developing nations enjoy from higher commodity prices, especially energy exporters.

“A lot of EMs, especially in Latin America and EMEA are net oil exporters, so higher energy prices will benefit them,” said Brendan McKenna, a currency strategist at Wells Fargo in New York. “The countries that will be hurt the most are actually in EM Asia. Most EM Asian countries are oil importers and energy also makes up a big part of the inflation basket.”

 

The Thai baht, Indian rupee and Philippine peso have led Asian currencies lower against the dollar over the past month.

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Still, many local currency bond markets have already been “front-running” the view that inflation pressure would be sustained, according to Mark Baker, head of fixed income in Hong Kong at abrdn. In Latin America, several hundred basis points of rate hikes have been priced in, making the risk/reward attractive in countries like Brazil, Colombia and Mexico, he added.

“Even within Asia, where we haven’t seen the same degree of inflation pressure, markets are already pricing in policy rate normalization in places like Korea, India and Malaysia,” Baker said. “We see value in these local rate markets too.”

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Avoid Gold

And don’t expect gold to come to the rescue. For Mary Nicola, a portfolio manager at PineBridge Investments, the yellow metal won’t work as an inflation hedge in the current environment.

“Gold does better in an environment where you have an increase in money supply,” she told Bloomberg Television. “If we’re looking from an overall perspective we don’t see a supercycle in the commodity space, especially when we see slower growth coming out of China.”