High inflation makes investors look for risky assets

The craze for risky assets in the market has driven stock indices and cryptocurrencies to new records. Market participants see the sharp rise in inflation and the unattractiveness of government bonds as the main reason for this.

Last week, real returns, excluding inflation, hit one of the lowest levels in history. As a measure of real returns, the ten-year inflation-linked bond fell to 1.2%, according to Tradeweb.

Essentially, when real returns are negative, the purchasing power of the money invested in bonds gradually decreases over the life of those bonds.

Real yields have fallen due to many factors, including US inflation at its highest level in 30 years and nominal bond yields rising only slightly as central banks in developed countries are not yet ready to hike rates.

The prospect of negative inflation-linked bond yields has led investors to look for riskier investments.

“Amid negative bond yields, the lower the yields, the more speculative they are,” said Lorenzo Di Mattia, chief investment officer of the Sibilla Capital hedge fund. With cash eroded by inflation, investors have an even greater incentive to get higher returns, he said.

One of the signs of speculation is the 29% jump of the electric car startup Rivian Automotive on the stock exchange on November 6th. The stock rose over the next two days and is now more valuable than one of Rivian’s major shareholders, Ford Motor, though the startup didn’t begin shipping vehicles until September 2021.

Digital currencies exploded. Bitcoin hit a record close to $ 69,000 on November 5. Meanwhile, major Wall Street stock indices fell just 2% from their all-time highs last week.

Inflation has been a major concern of the market in recent months as investors and analysts alike wonder whether or not supply chain disruptions and labor shortages are short-lived.

The central banks of developed countries continue to claim that the rise in inflation is only temporary. Fed and European Central Bank (ECB) officials have downplayed the possibility of a rate hike in recent weeks. ECB President Christine Lagarde also said the possibility of a rate hike in 2022 was very slim.

The real yield on German bonds fell to minus 2.2%, close to a record low.

Shaniel Ramjee, fund manager at Pictet Asset Management, has bought aggressively into growth stocks like green tech companies and has taken the added risk of buying small-cap stocks.

“Negative real returns have encouraged greater risk-taking,” said Ramjee. As inflation increasingly undermines portfolio value, investors are investing in riskier assets with higher potential returns to offset inflation, he said. “I think inflation is the driving force behind the recent equity rally.”

When real returns decline, technology stocks – which have future growth prospects – benefit the most. The Nasdaq Composite is up about 10% over the past month, almost double the Dow Jones Industrial Average, which places heavy weight on traditional industrial and financial companies.

As for digital currencies, their performance in a high inflation environment is really unclear. Investors and analysts disagree: whether the value of the digital currency results from the additional risk for investors or the role of the inflation hedge. Bitcoin sold earlier this year amid growing inflation worries.

“The environment of lower returns and increased risk appetite really speaks for cryptocurrencies,” said Joel Kruger, currency strategist at LMAX Group for crypto and currency exchanges. However, if inflation rises enough to require the Fed to raise interest rates and reduce lending to the economy, it could hurt overall risk appetite, he said.

Vu Hao (according to WSJ)

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