The biggest risk to investors right now is an unexpected jump in
inflation, but it's still being overlooked, according to multiple
leaders at BlackRock. The $6.8 trillion investment firm recently flagged
the potential damage this event could do to portfolios, and shared its
recommendation for how to hedge the risk.Click here for more BI Prime
stories. Various Wall Street firms have flagged similar risks that
stock-market investors should have on their radars right now. These
include a profit slowdown, the US elections, lack of progress on trade,
and a corporate-credit crisis. But one risk that is not being talked
about nearly enough is inflation, according to BlackRock, the world's
largest money manager with $6.8 trillion in assets.This apparent
oversight can be explained by the fact that inflation — defined as a
sustained increase in prices across the board — has lived below
expectations for a long time. The Federal Reserve's favorite gauge of
inflation has averaged 1.5% over the past decade according to Bloomberg
data, missing its 2% target.Additionally, a separate measure compiled by
BlackRock shows there has yet to be an inflation surprise comparable to
the oil-price shock of the 1970s. It is represented in the red area
chart below.To get more news about
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Even BlackRock does not consider an inflation shock next year as a
likely event. However, multiple leaders worry about the damage such a
surprise could do to their clients' portfolios, they are flagging the
danger before it's too late.Inflation is “the hidden risk longer-term”
given how few investment professionals have experienced it, said Tony
DeSpirito, BlackRock's chief investment officer for fundamental US
active equities, at a recent media briefing. Marilyn Watson, the head of
global fundamental fixed income strategy team, was in agreement along
with Mike Pyle, the global chief investment strategist. All three of
them had the same response to a question about the most underappreciated
risk in the market right now.
A 'high-impact event'Pyle elaborated that their concern is about how
inflation would impact diversified portfolios of stocks and bonds.When
stock prices fall in a fear-filled climate, bond prices typically rise
as investors flock to a safer asset. In other words, bonds and stocks
normally have a negative correlation with each other. But if inflation
rises above prevailing bond yields, bonds would lose their appeal to
investors as a safe haven. This could upend the negative correlation and
alter the diversification benefit of bonds, Pyle said.
“That is a really high-impact event — even if it's really low in
probability risk — and one that's very unappreciated by market prices,”
Pyle said. Higher inflation could stem from a rebound in economic growth
— a prospect that would not be far-fetched if more progress is made on
the US-China trade front.On Friday, the US announced it agreed to lower
the tariff rate on China to 7.5% from 15% and cancel plans to target
virtually all imports from that country. Following this news, the bond
market's inflation expectation over the next decade — US 10-year
breakevens — rose to 1.75%, the highest since July according to
Bloomberg data. The big picture still has not changed. So what's an
investor to do in order to protect themselves from a real surprise?
BlackRock recommends buying Treasury Inflation-Protected Securities, a
category of US government bonds that work as advertised because their
yields are indexed to inflation. And if you would rather not buy TIPS
directly, BlackRock has an exchange-traded fund for you: the iShares
TIPS Bond ETF.
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