‘Team Transitory’ Joined by Citi Strategists in Inflation Debate

(Bloomberg) -- It may be time for investors to start positioning for inflation moves -- but not in the way they think.

The hottest debate in economics this year has been whether rising prices will be sticky or short-lived. And “team transitory” just got a nod of support from Citigroup. While inflation will likely keep climbing in the next few months, the bank’s strategists led by Scott Chronert are urging clients to start positioning for the decline. 

Why? Because the bank’s estimates show that the Federal Reserve reducing bond purchases, coupled with a gradual easing of supply-chain bottlenecks, likely means that core inflation for this cycle will peak in February. So, investors should consider reallocating into sectors like consumer and health-care stocks that carry a negative correlation to changes in consumer prices, the Citi strategists wrote in a note titled “The Changing Inflation Narrative.” 

They acknowledge that the call is contrary the Street’s focus on current supply-chain snarls that have led to a global shortage of goods and pushed up prices for everything from computer chips to construction equipment. But their view is based on the change they see coming in a few short months.

“We think it is time to rethink positioning related to inflation,” the strategists wrote. “A focus on sectors and industry groups negatively correlated to inflation provides a contrarian opportunity.”

The relationship between inflation and different industry groups is evolving, which makes it difficult to determine which sectors to focus on, the bank’s strategists warn. Historically, the sectors that have have been most negatively correlated to CPI include: consumer-discretionary and staples stocks, health care, information technology and communication services, they wrote.

Fed Chair Jerome Powell last week officially announced the central bank was starting to reduce its bond-buying program and acknowledged that supply constraints have been larger and lasted longer than expected. The immediacy of the taper likely means that inflation risks are now front-and-center in policy makers’ minds, says Anna Wong, chief U.S. economist for Bloomberg Economics.

Read: U.S. REACT: November Fed Taper Start, Hints of 2022 Liftoff (2)

Since the stock market bottom in March 2020, the stocks most highly correlated with inflation have jumped 156%, when adjusting for sector biases, compared with a 100% rally for those that are the least correlated, data compiled by Credit Suisse show.

Citi’s Chronert, who assumed Tobias Levkovich’s role on an interim basis after his death, made his debut forecast in late October, when he estimated that the S&P 500 will rise to 4,900 by the end of next year.

Investors will get a better read of price pressures in the CPI data due Wednesday. Consumer prices are expected to have risen 5.9% last month, the fastest acceleration since 1990, according to a survey of 39 economists. Traders may also get more clarity from this week’s Fed speakers, including Powell, who’s expected to participate in a virtual conference on economics and inclusion on Tuesday.

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