The author is the CEO of AllianceBernstein

Expectations of future inflation Steadily increasing In the past year, it is now higher than before the pandemic.

This sparked a heated discussion about the impact that rising inflation, rising bond yields, and the recent sell-off of some well-known, fast-growing companies may have on financial markets.

It is not surprising that the inflation rate in 2021 is higher than the levels of the past two to three years, as it almost mechanically follows the pent-up consumer desires of many households due to the Covid-19 pandemic, leading to an increase in the inflation rate Demand exceeds supply.

The key question for investors to ask is whether this kind of inflation can continue after the “reopening of trade.” We believe it can.

We believe that the main driving force for rising inflation is changes in the policy environment, which may make it possible to use fiscal tools more actively. This will be necessary because policymakers will have to overcome the deflationary forces that may emerge after the reopening of trade ends, including the continued trend of weak labor markets and technology depressing prices.

However, policymakers may be more inclined to increase inflation moderately to reduce the value of higher debt levels. This leads us to believe that investors will encounter the problem of duration, which is a measure of the time it takes for investors to recover asset prices through cash flow.

Another way to think about duration is that it represents the sensitivity of asset prices to changes in the rate of return. Think about it this way, it can be applied to all asset classes, not just bonds.

As yields have fallen in recent years, the duration of high-grade bonds has increased—that is, they have become more sensitive to changes in yields, because even small fluctuations at lower levels will have an impact on investors’ time The money that greatly affected them came back. Therefore, if interest rates rise, bond investors now face greater risks.

So far, simple cross-asset portfolios, such as those that use a 60:40 allocation for bonds and stocks, have not been affected by this. This is because these asset classes have been negatively correlated in recent decades-when the stock market falls, bonds rise, and vice versa.

If inflation rises sharply, this is unlikely to happen. Under moderate levels of inflation, bonds will be sold off, but as returns increase, stocks will be more resilient. But in the case of high inflation, both stocks and bonds will be affected by rising interest rates.

In the end, this overturned the argument of the past decade that investors are increasingly making passive long investments in stocks and fixed income.

In view of this policy environment, this approach itself has greater risks. If fixed income no longer hedges equity risk, then a new cross-asset investment model may be needed. This raises questions about many popular methods that individuals use to save for retirement.

Investors should adjust to hold more “physical” assets and take clear actions to reduce duration risk. Physical assets include physical assets such as infrastructure and real estate, but one can argue that public stocks can be counted as a physical asset because dividends will rise with inflation.

Another area where demand may arise is the digital tokens of physical assets maintained in the “blockchain” of the entire network. In this regard, this may be the technology used in the right place at the right time.But the real driving force for adoption will be real asset requirements, not technology itself.

Any long-term inflation may also support the strategy of buying undervalued companies or value investments in the market. Such assets usually have a high rate of return, so a large part of the present value comes from recent cash flows.So they are not very sensitive to changes in long-term interest rates

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There are still many unfavorable factors in the value factor, especially the way technology has destroyed the “moat” that protects certain industries from competition. These prompt the question of how to measure “value”. But if inflation continues to rise, value strategies can become part of investors’ response to the issue of duration.

If our new policy environment produces a more durable narrative of inflation, then investors need to deal with the challenge of duration more broadly in their portfolios. This may overturn many long-standing assumptions about proper asset allocation.

Inigo Fraser Jenkins, co-head of portfolio strategy at Bernstein Research, provided research and analysis for this article