For years, investors have relied on a classic toolkit of bonds and gold to cushion their portfolios during turbulent times. But with inflation refusing to fade, those tools may no longer be up to the task according to Karen Ward, chief market strategist EMEA at JP Morgan Asset Management.
“We haven’t had inflation shocks for 20 years, so it’s a new experience for many,” she said. “But bonds don’t help you when the problem is inflation. That’s where we need to think about other diversifiers, things that are going to work if inflation is the outcome.”
Gold has historically served that purpose, and Ward acknowledged that many investors have already turned to it. But now that may be a case of too little, too late. “Gold is one option if you need to stay liquid,” she said. “But we think there are better solutions, particularly in the alternatives space.”
She warned that markets are once again underestimating the risk of another inflationary episode. “The market was caught off guard in 2022, and I think that was seen as a one-off. But we are nervous about the inflation trajectory over the second half of the year.”
If another shock hits, she added, it may not be clear whether it hurts growth or pushes prices higher, but either way, portfolios need to be ready. “We want shock absorbers not just for recession, but for inflation as well,” said Ward. “They’re equally weighted in our priority list.”
This rising uncertainty also explains her view on central banks. Ward has long believed the Bank of England would be slower to cut rates than markets expect, a view she still holds, citing the UK’s persistent inflation problem as “the least transitory” and “the most deeply rooted”.
Gold and bonds under pressure
Hugh Gimber, global market strategist at the firm, echoed Ward’s concern that investors may be relying on outdated playbooks.
“Fixed income is still an excellent diversifier against a growth shock,” he said, “but not against the full range of outcomes we might face over the next six to 12 months.”
Even if bonds deliver strong returns in a downturn (Gimber estimated a 14% gain on gilts or treasuries if yields fall by 100 basis points) their value in a stagflationary environment is far more limited.
“There should be a level where bonds lose their attractiveness and we think that’s somewhere between 3.5% and 4% yields in both the US and UK.”
As for gold, while it remains a viable inflation hedge for some, Gimber questioned how much upside remains after a powerful rally. “Gold is already up 40% year to date,” he said. “A lot of the concerns investors are trying to hedge against already appear to be priced in.”
Alternatives and real assets rising
In this context, both Ward and Gimber urged investors to broaden their idea of what true diversification looks like.
“We’ve got to have this other range of diversifiers,” said Ward. “These are the shock absorbers to the new shock in our life of inflation. It was so easy to put together a portfolio over the past 20 years and life’s just not that easy anymore.”
Real assets such as infrastructure or core property may play a more effective role going forward, particularly when inflation is the source of volatility.
Gimber added: “If you’re in an environment where inflation is the cause of the shock, core real assets such as infrastructure, real estate, transport and timber look to be by far the most effective diversifiers.”
Regional equities and income resilience
As for equities, income and regional diversification is the way to go.
“Unlike the past 10 to 15 years, we think a regionally diversified equity portfolio will offer far stronger risk-adjusted returns than a heavily US-concentrated one,” said Gimber.
Despite some rotation into Europe this year, he said sector-level discounts remain abnormally large, but that relative value could prove vital in an environment where US earnings expectations remain “overly optimistic.”
“You’re asking for something we’ve never seen historically,” he said. “There’s a disconnect between our macro outlook and what the market is pricing in when it comes to US earnings. Valuations on the S&P 500, excluding the mega-caps, haven’t moved year to date, and even the mega-caps are still trading at around 27x earnings.”
Instead, Gimber sees income strategies – especially in markets like the UK – as more attractive. “This isn’t a slowdown because companies are over-leveraged and need to repair balance sheets. They’re choosing to retrench,” he said. “That means more cash stuck on balance sheets, available for dividends and buybacks.”
He added: “Dividends historically fall by about half the size of an earnings drawdown, but this time, with low payout ratios and capex being pulled back, the case for dividend resilience is stronger than usual.”