Real Asset Strategies: Timing Isn’t Everything, but… by Jon Ruff, AllianceBernstein
Real assets are coming off of a horrendous year relative to diversified stocks. Meanwhile, inflation is expected to stay low indefinitely. So why in the world should anyone own real assets now?
In 2013, real assets – defined as equal parts commodity futures, real estate investment trusts (REITs) and natural resource stocks-experienced their third worst year versus the S&P 500 Index since 1970. An economic slowdown in China and a rise in US bond yields created headwinds for commodity and REIT prices, respectively. Market participants seem to have concluded that there’s barely any chance that inflation will pick up.
Nonetheless, we think there are three reasons why investors should consider an allocation to real assets:
First, making a strategic allocation to real assets can guard against macroeconomic environments in which stocks and bonds decline simultaneously. We don’t recommend making tactical bets on inflation, because inflation is notoriously hard to predict.
Second, the fact that forecasters predict little chance of an inflation spike is irrelevant—or even bullish for inflation-related assets—because they have such a poor track record of forecasting inflation. Since 1950, actual inflation was, on average, 1.5% above or below the forecasts of just one year earlier—and was sometimes off by more than 5% (Display 1).
When monetary policy is changing—as it will over the next couple of years—the misses tend to come in waves. If inflation surprises forecasters on the upside by, say, the 1.5% historical average over the next few years, the US Federal Reserve will face a dilemma. If it tightens policy faster than expected, it could choke off the stuttering recovery. If it leaves policy loose, it could risk a much larger inflation outbreak.
In either environment, real assets should outperform diversified stocks; in the second environment, real assets should also outperform bonds. Investors should be prepared for at least the possibility of such outcomes.
Third, real assets have bounced back strongly after past periods of extreme underperformance. There were only two years, 1975 and 1998, when real assets underperformed the S&P 500 by more than they did in 2013. Real assets’ underperformance in 1975 reflected the collapse in inflation following the first 1970s spike. Their underperformance in 1998 reflected the market perception during the tech bubble that real assets were “old economy” investments. However, real assets outperformed the S&P 500 by more than 30% over the three years following 1975 and 1998, and by more than 65% over the next five years (Display 2).
Today, the rubber band of relative valuations and performance between real assets and broader markets is tightly stretched. We think that makes now an interesting time to consider implementing a strategic allocation to real assets.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams. MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.
Jon Ruff is Lead Portfolio Manager and Director of Research for Real Asset Strategies at AllianceBernstein Holding LP (NYSE:AB).