Hands-up anyone who made substantial changes to their investment portfolio in the last 3 months.

While this is clearly tongue-in-cheek, it is a relevant point. Inflation is higher than it has been for four decades, and it is unlikely many investors were positioned three months ago exactly how they wanted to be, considering what we now know. And a lot has changed. The quantum of the rise in inflation is stunning in itself…and it is going higher. 

For those of you that follow our commentaries, you will know that Algebris has been shouting ‘inflation’ from the rooftops for more than 6 months. Now with energy costs soaring, few people can have remained oblivious to the initial effects. Too many numbers are being thrown around by market participants, but everyone gets the bigger picture. Inflation is the highest it has been for more than a generation. The Fed and Bank of England have started to act, raising short term interest rates. It is probably too much of a step change for the ECB to act quickly but even it turned hawkish at the last meeting.

Taking a step back to just observe the highest inflation rates in a generation (see chart below), combined with the lowest interest rates in a generation, it is obvious that the world should not have the lowest interest rates in a generation. This is the end of the monetary experiment that we have seen post Global Financial Crisis. There aren’t many traders in investment banks or wealth managers currently managing portfolios, or selecting funds, who have experienced inflation.  This will require a change in thinking and portfolio positioning.

Perhaps the most important question for investors is, ‘What can I invest in that yields more than inflation’? Even if we assume inflation falls closer to 3%-4% by the end of the year as some large Covid related base effects roll-off, there aren’t many assets yielding above that. In addition, with QE likely to be reversing, there is still the chance of a further re-pricing downwards for a lot of bonds.

Importantly, sub-ordinated financial bonds were never part of the QE programs, so should not miss the lack of a central bank 800lb-gorilla-buying-programme. Additional Tier 1 securities now yield >5% while European bank equity (those without Russia exposure) also yield >7%. There are deep pockets of value in global banks (European banks in particular) and financials in general, that benefit from inflation and increasing short/long term interest rates. There aren’t many sectors that offer this.