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Higher inflation for the next 5 years: 'be overweight stocks, gold, and commodities,' says WisdomTree's research head

Kitco News

(Kitco News) Higher prices are a reality that is here to stay, at least for the next five years, according to WisdomTree global head of research Jeremy Schwartz, who identities a number of new risks facing investors' portfolios.

"One of our big picture views is that inflation is not temporary. You've heard this narrative from the Fed — is it temporary or permanent? And we have a view that over the next few years, you're going to have above-average inflation from what the market has been expecting historically," Schwartz told Kitco News.

The main drivers behind longer-lasting inflationary pressures will be higher demand, increased money supply, and rising money velocity, Schwartz explained, pointing to a sharp increase in the M2 money supply in the U.S. over the past year.

"The thesis boils down to all the COVID relief measures that have put a huge amount of money in the system," he said. "One of the measures that we track is the M2 money supply in the U.S., which is up 40% over the previous year before the pandemic. And this is cash in people's checking accounts."

As the economy reopens, that saved money starts to go back into the system. "You see it in today's labor shortages, supply pressures, and that's going to continue," Schwartz noted. "You had about $6-$7 trillion relief measures introduced to offset the pandemic."

The COVID-19 pandemic was not a typical crisis either, WisdomTree's global head of research added. The U.S. did not have to deal with a lot of market imbalances. And now, as consumers get back to normal lives, inflation could rise 20% over the next five years.

"You close the economy. You put a lot of money in people's checking accounts to offset their lost income. And as you reopen, the pent-up demand is going to come out and be this cumulative price pressure increase of let's call it 20% over the next three to five years," he said. "It will have a more permanent impact due to that higher money supply, wage and supply pressures."

More permanent inflation poses several significant risks, especially when it comes to protecting investments.

"If inflation is much higher than people expect, that's where you start to look for other diversifiers. And that's where we think things like commodities could have a big role," Schwartz pointed out.

WisdomTree's recommendation is to move away from bonds and embrace an overweight position in stocks, gold, and other commodities.

"We're looking for inflation hedges and alternatives to bonds, which we believe are challenged in the face of this inflation that we expect. We're overweight equities, overweight commodities from a traditional 60/40. We roughly have 3% in gold and 3% in broad commodities for the combined cyclical commodity broad-based exposure," Schwartz said. "Gold is an inflation hedge, which is a little bit more of a defensive asset, and broad commodities are a little bit more cyclical."

In response to more persistent price pressures, the central bank could move up its rate hike timeline to 2022, he explained.

"We've been saying that they may have to announce the taper by the end of the summer.

And we could see the September dot plot going from 2023 for the first hike to 2022, with even a few people putting it at 2021," Schwartz stated. "The more evidence they get that inflation is not just temporary by the end of the summer, the more likely they are to start indicating their taper plans."

Markets' most likely reaction to even more hawkish surprises from the Fed could be more volatility. And this is where gold comes in, he added.

"We don't think it's going to be a taper tantrum like before, but market tremors along with volatility are something to watch," Schwartz said. "We do like things like the industrial metals as well in the sense that we think there's some longer-term shift to EV battery-type energy, and some of the industrial metals from copper and nickel benefit from that."

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