How to invest through rising inflation

US inflation rose more than expected in April with the Consumer Price Index coming in at 4.2% – its highest level for more than a decade*.

While high, the figure is not too much of a surprise: a number of economists and fund managers said just a couple of weeks ago that US inflation could rise to 4% given that we are coming from a very low base year-on-year.

April saw the largest monthly increase in the index for used cars and trucks since the series began in 1953, and the largest monthly increase in the index for all items less food and energy since April 1982*. The figure could even rise further in the next few months as economies reopen.

“There are two questions on investors’ minds,” commented Darius McDermott, managing director of FundCalibre. “The first is whether the high numbers will cause central banks to freak out and raise interest rates faster and higher than they currently intend. At the moment, the rhetoric from the Federal Reserve at least suggests not.

“The second is whether this inflation is transitory or whether it will turn out to be more embedded in the system than it has been for many years. At the moment it would seem a short-term phenomenon, but we are not going to know whether that assumption is correct for a good few months.

“I expect there to be quite a bit of volatility over the summer as markets digest the numbers and listen closely to central bank meetings.”

Inflation or deflation? Six investors give their views

What should investors do?

Inflation is historically bad for bonds, but there are ways that managers can limit the damage done to their portfolios.

Richard Woolnough, manager of M&G Optimal Income, M&G Corporate Bond and M&G Strategic Corporate Bond funds gives us his views in this podcast:

When it comes to equities, there are a number of options, depending on your personal view on the direction of inflation:

Buy value strategies

If you believe in the inflationary trade lasting longer than expected, you could invest in value strategies. In the UK this would include the likes of JOHCM UK Dynamic and TM CRUX UK Special Situations. Globally, Schroder Global Recovery and Ninety One Global Special Situations are worth a look.

Top up growth

If you think inflation is a short-term issue, then you could buy growth strategies on the market dips, getting a much better price than has been available in recent months. For example, Marlborough Multi-Cap Growth or AXA Framlington UK Mid Cap in the UK and Premier Miton Global Smaller Companies or Brown Advisory Global Leaders.

Invest monthly

If you want to dampen some of the likely volatility, then investing monthly, rather than trying to time the market with lump sum investments, could help you get through the summer with fewer sleepless nights.

*Source: US Bureau of Labor Statistics, 12 May 2021