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Economic and Market Commentary

Quick Takes: Navigate Inflation Concerns with a Multi-Asset Approach

Economic uncertainty can make it challenging to protect investments against inflation. Learn why using a range of real assets, like TIPS and commodities, may provide extra diversification benefits to a 60/40 portfolio.

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Text on screen: PIMCO Quick Takes: Navigate Inflation Concerns with a Multi-Asset Approach

Text on screen: Greg E. Sharenow, Portfolio Manager, Commodities and Real Assets

Sharenow: As we can all attest to, inflation has hit our pocketbooks, it's hit the markets, it has become a central part of the political dialogue. In 2022,

FULL PAGE GRAPHIC: TITLE – Persistent and broadening inflation led to a rapid re-pricing of Fed hikes. A line chart is shown; the subtitle for the chart reads: Higher than expected. It shows three lines. The blue line represents Core Goods. The green line represents Core Services. The black line represents the Core Consumer Price Index (CPI). All three lines showed significant increases. The biggest increases were in Core Services and Core CPI, which rose from approximately 2% in January 2019, to above 4% in mid- to late 2021, and to above 6% as of October 31, 2022.

as you can see core inflation, both goods and services, have been on the rise and have hit over 6%.

As we look to 2023 we still expect inflation to be high, although begin to moderate some.

FULL PAGE GRAPHIC: TITLE – Persistent and broadening inflation led to a rapid re-pricing of Fed hikes. A line chart is shown; the subtitle for the chart is Overshooting? It shows four lines plotted against the federal funds rate (%) on the left axis. The dark blue line represents the median federal funds rate expectations from the Federal Open Market Committee (FOMC) during its December 2021 meeting. The green line shows the FOMC’s median fed funds rate expectations during its March 2022 meeting. The red line shows the FOMC’s median fed funds rate expectations at its June 2022 meeting. The light blue line shows the FOMC’s median fed funds rate expectations at its September 2022 meeting. The chart shows the median expectations moving significantly higher, from below 1% at the FOMC’s Dec. 2021 meeting, to below 2% at its March 2022 meeting, to near 3.5% at its June 2022 meeting, to below 4.5% at its September 2022 meeting. The median expectation for the fed funds rate shows an increase to above 4.5% in 2023, trending down toward 2.5% after 2024 and beyond, based on median expectations during the September 2022 FOMC meeting.

The rise of inflation has led to significant changes in expectations for the fed in terms of the amount of hikes and to the level for which they are going to hike over the course of 2022 and 2023.

This has had a negative impact on asset pricings broadly, as we've seen with the selloff in equity markets and the retracement in fixed income markets.

The inflation backdrop has meaningful implications for investors.

FULL PAGE GRAPHIC: TITLE – Asset class sensitivities to growth and inflation surprises. The chart shows four shaded sections measured by inflation, which measures asset price movements in response to an increase or decrease in inflation, and Growth (bottom scale). The upper left corner in light blue, High inflation, Low growth, shows assets Gold and Treasury Inflation Protected Securities (TIPS). The upper right corner in green, High inflation, High growth, shows Commodities, REITs and Emerging Markets Currencies. The lower left corner in dark blue, Low inflation, Low growth, shows Core Fixed Income and Treasuries and U.S. Core Bonds. The lower right corner in red, Low inflation, High growth shows Non-Inflationary Growth, Low inflation, High growth, with Equities and High Yield.

We would expect equities to perform well in a high-growth and stable- and low-inflation environment, while fixed income the opposite in low growth. As a result, a traditional 60/40 portfolio would benefit from the diversification of owning both fixed income and equity.

The problem becomes when inflation rises and becomes less stable. In this environment, we have seen that the correlations between fixed income and equity reverse and become positive.

What asset classes could investors look to in this environment to help insulate the portfolio?

In an environment where you have high growth and high inflation, one of the best inflation-fighting assets tends to be commodities.

Now in a low-growth, high-inflation environment we would expect TIPS and gold to be an asset class that performs quite well.

Text on screen – Key Take-aways: Real assets can provide diversification across economic environments, Different types of real assets can react differently to changes in economic growth, Given macro uncertainty, investors may want to consider a multi-real asset approach

The key takeaway for investors are as follows: given the highly uncertain macro backdrop, thinking beyond a 60/40 portfolio, including real assets, can provide broader diversification across economic environments. TIPS and commodities share a linkage with inflation but can react differently to surprises in GDP and the resulting risk-on or risk-off market environment.

Investors may want to consider a multi-real asset approach that can provide broader diversification to traditional equity and bond portfolios.

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