A New Look across Asset Classes
May 5, 2009
Instead of looking at data when there was a one-off quick shock, Roache believes different results would emerge as a result of disinflation, slow changes, or anticipated changes. “Over those sorts of periods equities might recoup losses that they suffer over the shock, but this model doesn’t capture that,” he said.
High inflation – over 5% – makes bond investors very nervous, according to Roache, and they ask for high real rates. “Equity investors don’t like high real rates,” he said.
When real interest rates fall and inflation is under control, then equities outperform, which is what happened in late 1980s and 1990s,
Bonds similarly suffer from the initial inflation shock, but eventually recover:
Roache said that a lot is driven by the experience of 1980s. “Bonds really sold off when investors believed the inflation shock might be permanent,” he said. Bond investors then asked for a higher risk premium – a higher real yield to protect against further surprises. “At some point yields stop rising and, once you get to that point, bond investors benefit from very high coupons and real yields-to-maturity,” he explained, adding that the process takes time and eventually levels off.
Commodities offer short-term relief from inflation, but those benefits dissipate over time:
Gold tends do much better than other commodities. “Other commodities vary depending on their unique supply-and-demand fundamentals, whereas gold has a more stable profile,” Roache said.
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