Real Assets Outshine if Inflation PersistsRealAssetsOutshineifInflationPersists

The four-decade trend in falling U.S. inflation has halted after rising over 7.0% in 2021. Given current inflation measures, these recent price pressures may remain elevated over the next several quarters. While our baseline long-term inflation expectations assume a reversion to longer-term trends, the nearer-term outlook for inflation is highly uncertain.   

Short-term: As prices continue to rise, inflation is at its highest level since 1981 and will likely remain elevated for the next several quarters. Although some transitory components, such as durable goods prices, should subside and help steer inflation lower, the real test for whether inflation will exceed the Fed’s targeted mid-2% range, on a sustained basis, will depend on how policymakers respond as the economy nears full employment. With the recent round of rate hikes, policymakers are responding, though it will take time to see policy measures impact the real economy and prices. 

Long-term: Long-term inflation is expected to be somewhat higher than in the period between the Global Financial Crisis of 2008 and COVID-induced recession of 2020. During the past four periods since 1950 when inflation exceeded 5%, it took anywhere from 17 to 122 months for it to climb from and then recede back to its long-term average of 3.5%. While an extreme scenario of 1970s-style, double-digit inflation appears unlikely, the potential for a sustained period of average inflation well above central bank targets is a non-trivial risk for investors. 

Real asset classes that help hedge inflation

If inflation remains elevated it may be challenging for a traditional balanced portfolio concentrated in stocks and bonds to deliver positive real returns. The good news is that there are public market investment options to real assets that may perform materially better than stocks and nominal bonds in higher-inflation regimes, both on a historical and forward-looking basis. While a 100% allocation to real assets may not be palatable or possible for many asset owners, adjusting portfolio allocations to allow greater exposure to real assets can potentially and meaningfully improve expected portfolio outcomes in an elevated inflation regime. 

Bloomberg U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. It covers the U.S. investment-grade, fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. S&P 500 Index is an unmanaged index of 500 common stocks of large U.S. companies, weighted by market capitalization. 60/40 is a hypothetical portfolio represented by a 60% allocation to the S&P 500 Index and a 40% allocation to the Bloomberg U.S. Aggregate Bond Index, rebalanced annually. Real Assets Portfolio is a hypothetical portfolio represented by an equal allocation (rebalanced annually) to these indexes: Bloomberg Commodity Index (commodities), Natural Resources—from 5/1998 to 10/2002, the S&P North American Natural Resources TR Index from 11/2002 to 3/2019, the S&P Global Natural Resources (Net) Index (natural resources), Global Infrastructure—from 5/1998 to 10/2001, the S&P 500 Utilities Sector Index from 11/2001 to 3/2019, the S&P Global Infrastructure Index (infrastructure), FTSE NAREIT U.S. REIT Index (U.S. real estate), FTSE EPRA/NAREIT Developed Ex U.S. Index (non-U.S. developed real estate), London Bullion Market Association (LBMA) Gold Price Index (gold), Bloomberg U.S. TIPS Index (U.S. TIPS), and Alerian MLP Index (MLPs). Average annual index returns do not include the effects of sales charges or operating expenses. If they had, these returns would have been lower. Indices are unmanaged and are provided for informational purposes only. Investors cannot directly invest in an index. 

Risks—Investing involves risks. Some investments are riskier than others. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost. Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, and political and economic uncertainties. Investing in emerging markets is very risky due to the additional political, economic, and currency risks associated with these underdeveloped geographic areas. Investments in growth stocks may be especially volatile. Value investing involves the risk that undervalued securities may not appreciate as anticipated. It may take a substantial period of time to realize a gain on an investment in a small or midsized company, if any gain is realized at all. Real estate investment trusts (REITs) may not be suitable for all investors. There is no guarantee a REIT will pay distributions given the inherent risks associated with the market. A REIT may fail to qualify as a REIT as defined in the Tax Code, which could affect operations and negatively impact the ability to make distributions. There is no guarantee a REIT’s investment objectives will be achieved. Diversification and asset allocation do not guarantee profit or protect against loss. Investments in in Master Limited Partnerships (MLP) and MLP-related investments are subject to complicated and in some cases unsettled accounting, tax, and valuation issues, as well as risks related to limited control and limited rights to vote, potential conflicts of interest, cash flow, dilution, and limited liquidity and risks related to the general partner’s right to force sales at undesirable times or prices. MLPs are also subject to risks relating to their complex tax structure, including losing its tax status as a partnership, resulting in a reduction in the value of the MLP investment. Many MLP investments are in the energy sector and subject to a greater degree to risk of loss as a result of adverse economic, business, regulatory, environmental, or other developments affecting industries within that sector than investments more diversified across different industries. Diversification and asset allocation do not guarantee profit or protect against loss. 

The views expressed herein are those of investment professionals at PGIM Quantitative Solutions at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. This commentary is not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services. This commentary does not constitute investment advice and should not be used as the basis for any investment decision. This commentary does not purport to provide any legal, tax, or accounting advice. PGIM Investments LLC is a registered investment advisor with the U.S. Securities and Exchange Commission. PGIM Custom Harvest does not provide tax, legal, or accounting advice. This material is for information purposes only, and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. 

Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information, nor do we make any express or implied warranties or representations as to the completeness or accuracy. Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change. 

This material is being provided for informational or educational purposes only and does not take into account the investment objectives or financial situation of any client or prospective clients. The information is not intended as investment advice and is not a recommendation. Clients seeking information regarding their particular investment needs should contact their financial professional. 

Prudential Investment Management Services LLC is a Prudential Financial company and FINRA member firm. Jennison Associates, PGIM Custom Harvest, and PGIM, Inc. (PGIM) are registered investment advisors and Prudential Financial companies. PGIM Quantitative Solutions is the primary business name of PGIM Quantitative Solutions LLC, a wholly owned subsidiary of PGIM. PGIM Fixed Income and PGIM Real Estate are units of PGIM. © 2023 Prudential Financial, Inc. and its related entities. Jennison Associates, Jennison, PGIM Real Estate, PGIM, and the PGIM logo are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide. 

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