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It's often said that a generation or generations of advisors know nothing other than declining U.S. government bond yields and for advisors that got into the business in the mid-1980s and thereafter, that's mostly true.
There's another generational point of interest. Many clients haven't been engaged in financial markets in an inflationary environment as intense as the current one. When advisors think about it, the number of clients in that position is likely expansive because inflation is currently running at its highest levels in four decades, indicating that basically all clients that are Gen X and younger are experiencing their first bout with prolonged inflation.
Obviously, inflation is a drag and troublesome to advisors and clients alike, but there's also plenty of opportunity to bolster engagement thanks to inflationary pressure.
It's not just inflation that could cement advisor/client relationships this year. Inflation volatility, or the sheer jitteriness of inflation is an issue on which clients will require attention in 2022.
Macro Environment Is Haywire
Taking cues from inflation, the time is right for advisors to communicate with clients and chances are, clients will appreciate it.
“Not only is inflation higher, but it is also more volatile. During the 'Great Moderation' of the last several decades, both growth and inflation remained low but stable,” according to BlackRock research. “In the post-GFC period the standard deviation of monthly inflation readings was 0.07%, less than half the long-term average. Today, inflation volatility is at a multi-decade high and almost certain to continue to climb.”
What many clients don't realize is that, on a historical basis, there's not an intimate correlation between inflation and equity market performance. However, clients perceive inflation as problematic for riskier assets and many don't realize how to properly attack inflationary climates. That's one reason why advisors' value can shine in this setting.
“In the past, equity investors have been less willing to put a premium valuation on stocks when inflation volatility was elevated, as is the case today. And while historically low rates probably insulate stocks from significant multiple contraction, higher macro volatility will make higher valuations less likely,” adds BlackRock.
Establishing the Right Mindset
One of the certainties about rising inflation is that plenty of market participants, clients included, have ideas about what corners of the equity landscape are vulnerable and which ones offer upside potential. Thing is, much of this conjecture and speculation. It's not that clients have “bad” ideas, per se. It's more about them needing guidance in a hard-to-navigate macro environment.
Of course, advisors know that it is indeed true that some sectors and industries perform better than others when inflation runs hot. Those include, energy, materials and transportation names, which are part of the industrial sector.
“Not surprisingly, the sectors with the best relative performance when inflation is accelerating are cyclicals, more specifically energy, material stocks and industrials. Interestingly, financials did not make the cut,” concludes BlacRock. “One reason may be that while financials tend to outperform when rates are rising, as recent history has demonstrated, inflation and interest rates can diverge for extended periods.”
Bottom line: Investing during inflationary times is a lot like real estate. It's all about location. Advisors usually know the best locations and that's impactful today in client relationships.