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What the new normal rate of high inflation means for investors

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The writer is chief market strategist for Europe, the Middle East and Africa at JPMorgan Asset Management

Inflation panic recedes. Energy prices have stabilized and pandemic-related supply disruptions have eased. These factors alone must mean that inflation in the West is falling from the horrific double-digit rates we have seen recently.

Central banks seem increasingly confident that they have regained control. Bond and stock markets breathe a collective sigh of relief.

With inflation in double digits, investors are turning to the question of where it might eventually settle. Are we going back to the low inflation that has prevailed for most of the past two decades? Or will it remain at a higher level? In my opinion 3 percent will be the new 2 percent. This has major implications for investors.

The high rate of inflation and volatility of commodity prices is part of the story. One striking feature of the era of low inflation was that the basket of non-energy goods that the British consumer bought in 1990 was exactly the same 30 years later. I can’t see history repeating itself.

Commodity prices are likely to be subject to waves of commodity price inflation in the future, in the same way we saw this year. After the massive Russian invasion of Ukraine, the West lost its main supplier of many commodities.

This multi-year adjustment period will have cost implications as we move to alternative sources. Dependence on small producers in volatile parts of the world, or on renewable energy sources exposed to the vagaries of the weather, will lead to periods of shortages and price hikes.

In addition, the purchase of goods is no longer confined to the lowest cost. Controlling the supply of key inputs and the broader production chain is of paramount importance to businesses and governments alike. This may involve resupply or resupply to countries where it is more expensive to operate.

Central banks might argue that if commodity inflation is persistently higher, they will simply have to force service sector inflation lower. While true in theory, the political reality is less clear cut. In a complete reversal of the experience of the past 30 years, service-sector workers in the West will have to accept wage growth below the rate at which world commodity prices have been rising. Instead, I would expect central banks to accept a new, modestly higher rate of inflation.

In the end, I believe this upward shift will not only be accepted, but also welcomed. This is because the 3 percent inflation target would raise the average nominal interest rate by 1 percentage point other things being equal.

This would reduce the possibility of reaching the zero bound — the level at which interest rates cannot be cut to stimulate activity — and for central banks to resort to unconventional policy tools such as quantitative easing. In my view, it is now quite clear that QE is not a substitute for conventional monetary policy. It entangles the central bank with the government in a way that may threaten their independence, or at least perceptions of their ability to act independently.

Central banks are likely to balk at the idea that the inflation target should be raised until the latest episode of high inflation is well behind us. But investors need to consider the implications of a modest rise in global inflation.

Bond investors would do well to abandon the idea that 3 per cent will be the long-term neutral nominal interest rate. They must demand a higher return than in the past two decades on average plus a risk premium to recognize that there will also be greater volatility.

The implications for equity investors are less clear because earnings will grow at a slightly higher rate but earnings will also be discounted at higher interest rates. Companies that have operated in regions where their profits struggle against emerging market competitors may be the biggest beneficiaries — European companies come to mind. A higher and steeper yield curve should benefit global financial institutions, but would be a headwind for tech companies, for example. In turn, this would serve global value on stocks developing.

Finally, investors will need assets that protect them from occasional bouts of high inflation. Unfortunately, as this year very well shows, neither bonds nor stocks do the job. The best options here are private infrastructure, real estate, and timber, which have income streams more closely related to inflation.

Investors beware. Inflation woke up like a bad-tempered teenager – suddenly bigger, able to skimp on coffers and prone to bouts of volatility.

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Economic

We need to pay more attention to skewed economic signals

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The writer is chair of Queen’s College, Cambridge and advisor to Allianz and Gramercy

Inflation was the dominant economic and financial issue of 2022 for most countries around the world, especially for advanced economies that have a consequential impact on the global economy and markets.

The effects have been seen in declining living standards, increasing inequality, increasing borrowing costs, stock and bond market losses, and occasional financial mishaps (fortunately small and so far contained).

In this new year, recession, both actual and feared, has joined inflation in the driving seat of the global economy and is likely to replace it. It’s a development that makes the global economy and investment portfolios subject to a wide range of possible outcomes — something that a growing number of bond investors seem to be aware of more than their equity counterparts.

International Monetary Fund iYou will likely review soon Her economic growth forecasts again, predicting that “a third of the world will be hit by recession this year”. What is particularly notable to me about these worsening global prospects is not only that the world’s three major economic regions – China, the European Union and the United States – are slowing down together, but also that this is happening for different reasons.

In China, a chaotic exit from the wrong Covid-19 policy is undermining demand and causing more supply disruptions. Such headwinds to domestic and global economic well-being will continue as long as China fails to improve the coverage and effectiveness of its vaccination efforts. The strength and sustainability of the subsequent recovery will also require that the country more vigorously renew a growth model that can no longer rely on greater globalization.

The European Union continues to deal with energy supply disruptions as the Russian invasion of Ukraine continues. Strengthening inventory management and reorientation of energy supplies is well advanced in many countries. However, it is not yet sufficient to lift immediate constraints on growth, let alone resolve long-term structural headwinds.

The United States has the least problematic view. The headwinds to growth are due to the Fed’s struggle to contain inflation after mischaracterizing rate increases as fleeting and then initially being too timid to adjust monetary policy.

The Fed’s shift to an aggressive front-load of interest rate hikes came too late to prevent the spread of inflation in the services sector and wages. As such, inflation is likely to remain stubborn at around 4 percent, be less sensitive to interest rate policies and expose the economy to greater risk for accidents from additional policy errors that undermine growth.

The uncertainties facing each of these three economic areas suggest that analysts should be more careful in reassuring us that recessionary pressures will be “short and shallow”. They need to be open, if only to avoid repeating the mistake of prematurely dismissing inflation as transient.

This is especially important because these diverse drivers of recessionary risk make financial fragility more threatening and policy shifts more difficult, including potentially Japan. Get out of interest rate control Policy. The range of possible outcomes is extraordinarily large.

On the one hand, a better policy response, including improving the supply response and protecting the most vulnerable populations, can counteract the global economic slowdown and, in the case of the United States, avert a recession.

On the other hand, additional policy errors and market turmoil can lead to self-reinforcing vicious cycles with rising inflation and rising interest rates, weakening credit and compressed earnings, and stressing market performance.

Judging by market prices, more bond investors are better understanding this, including by refusing to follow the Fed’s interest rate guidance this year. Instead of a sustainable path to higher rates for 2023, they believe recessionary pressures will lead to cuts later this year. If true, government bonds would provide the yield and potential for badly missed portfolio risk mitigation in 2022.

However, parts of the stock market is still weakly bearish pricing. Reconciling these different scenarios is more important than investors. Without better alignment within markets and with policy signals, the positive economic and financial outcomes we all desire will be no less likely. They will also be challenged by the risk of more unpleasant outcomes at a time of less economic and human resilience.

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Economic

Macro hedge funds end 2022 higher, investors say, while many others take big losses By Reuters

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© Reuters. FILE PHOTO: Traders work on the trading floor of the New York Stock Exchange (NYSE) in New York City, US, January 5, 2023. REUTERS/Andrew Kelly

By Svea Herbst Baylis

NEW YORK (Reuters) – Some hedge funds betting on macroeconomic trends have boasted of double and even triple-digit gains for 2022, while other high-profile companies that have long been on technology stocks have suffered heavy losses in volatile markets, investors said.

Rokos Capital, run by Chris Rokos and one of a handful of so-called global macro companies, gained 51% last year. Fund investors this week, who asked not to be identified, said Brevan Howard Asset Management, the company where Rokos once worked, posted a gain of 20.14% and Caxton Associates returned 16.73%.

Haider Capital Management’s Haider Jupiter Fund rose 193%, an investor said.

Data from hedge fund research showed that many macro managers have avoided crumbling stock markets that have been rocked by rapid interest rate increases and geopolitical turmoil, including the war in Ukraine, to rank among the best performers in the hedge fund industry. The company’s macro index rose 14.2% while the general index of hedge funds fell 4.25%, its first loss since 2018.

Equity hedge funds, where the bulk of the industry’s roughly $3.7 trillion in assets are invested, fared worse with a loss of 10.4%, according to HFR data. And while that beat the broader stock market’s loss of 19.4%, some high-profile funds posted even bigger losses.

Tiger Global Management lost 56% while Whale Rock Capital Management ended the year with a 43% loss and Maverick Capital lost 23%. Coatue Management ended 2022 with a loss of 19%.

But not all companies that bet on technology stocks suffered. John Thaler JAT Capital finished the year with a 3.7% gain after fees after a 33% increase in 2021 and a 46% gain in 2020.

Sculptor Capital Management (NYSE::), where founder Dan Och is fighting the company’s current CEO in court over his salary increase, posted a 13% drop.

David Einhorn’s Greenlight Capital, which bet that Elon Musk would be forced to buy Twitter, ended the year up 37% while Rick Sandler’s Eminence Capital rose 7%.

A number of so-called multi-manager companies where teams of portfolio managers bet on a variety of sectors also boast positive returns and have been able to deliver on their promise that hedge funds can deliver better returns in distressed markets.

Balyasny’s Atlas Fund (NYSE: Enhanced) gained 9.7%, while Point72 Asset Management gained 10%. Millennium Management gained 12% while Carlson Capital ended the year with a 7% gain.

Representatives for the companies either did not respond to requests for comment or declined to comment.

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German automakers point to easing supply chain problems

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Sales at BMW and Mercedes-Benz jumped in the final months of 2022 as the German premium auto brands indicated supply chain problems plaguing the industry were abating.

Automakers around the world have experienced parts shortages since the pandemic, especially semiconductors, leaving many of them with large fleets of incomplete vehicles that can’t be delivered to customers.

BMW and Mercedes each said their full-year vehicle deliveries fell last year by 4.8 percent and 1 percent, respectively, due to Suppliers Bottlenecks as well as lockdowns in China and the war in Ukraine.

But supply pressures eased in the last quarter of the year, as BMW recorded a 10.6 percent jump in sales, with 651,798 vehicles delivered, and Mercedes fulfilling 540,800 orders, up 17 percent from the same period in 2022.

BMW He said the main effects of supply chain bottlenecks and continued lockdowns were felt in the first six months of the year, adding that “sales were steadily picking up in the second half.”

Mercedes boss Ula Kallenius told the Financial Times last week that the list of problems in the auto supply chain was declining, but added that long waits for cars would continue into 2023.

“One chip is enough to be vital [ . . .] Missing, and then you can’t finish the car, even if you have everything else.

Both brands recorded strong sales growth electric car. Mercedes, which last week announced a plan to build 10,000 charging docks, said EV shipments grew 124 percent to 117,800 last year compared with its predecessor.

Similarly, BMW reported strong growth in electric vehicle sales, with deliveries of fully electric vehicles doubling last year to 215,755.

Analysts at Bank of America said that sales of electric vehicles, including hybrid cars, reached a historic peak last November, with 1.1 million units sold. They attributed this largely to the upcoming phase-out of customer subsidies in Germany.

Participate in Mercedes BMW and BMW prices held steady Tuesday morning as investors priced in an image of an improving showing.

Rolls-Royce, a subsidiary of BMW, announced Monday that sales have hit a 119-year record, driven by strong demand in the United States, its largest market.

The luxury brand has been largely unaffected by the semiconductor pressure, mainly because it makes relatively few compounds and therefore needs fewer chips.

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