Inflation keeps rearing its ugly head amongst investor circles this year and that's got both individual investors and money managers planning to tackle the worst in 2022.
Whilst the core level of inflation seems to be faring better in Australia than other jurisdictions, the situation isn't nearly as glossy when factoring in all components of the consumer price basket.
Not only inflation, but the topic of interest rates is one of hot debate right now, as investors try to navigate the next moves of central banks in anticipation of a number of rate hikes in 2022.
The volatility has crept over into the Australian treasuries market, the benchmark equity index being the S&P/ASX 200 index (ASX: XJO) and AUD/USD forex rates, as seen on the chart below.
Alas, what is there to do in these pressing times, to counteract the dark forces of inflation and establish a reasonable hedge to the regime?
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What about QBE shares as a hedge to inflation?
Firstly, there needs to be some distinction on what we actually mean here. An inflation hedge can act as so in a few ways.
Most commonly, this is either by producing a 'real rate of return' (i.e, adjusted for inflation) that outpaces the level of aggregate price growth in the economy. If inflation is at 2%, say, then we want assets that produce a real return of at least 4%, for instance as a reasonable hedge.
The other way to look at it is in the correlation, or directional relationship, in how an asset class performs in times of high or low inflation.
This can boil down to a myriad of factors, not in the least related to asset class, investment style and/or, in the case of equities, the company backing stock itself.
Take insurance giant QBE Insurance Group Ltd (ASX: QBE) for instance. It lies within the insurance industry, one that is highly sensitive to small changes in interest rates.
Let's also remember that the Reserve Bank of Australia (RBA)'s main weapon in targeting headline inflation is its influence over interest rates in the economy.
Whilst the RBA doesn't touch commercial or consumer-level rates directly, it makes adjustments to the cash rate to do so, producing an impulse effect in the credit markets.
In a nutshell, when inflation rises, the RBA will seek to push interest rates higher to increase the costs of credit, and (hopefully) compress the level of price increases seen throughout the economy. The opposite is true when inflation stalls.
As the RBA looks well poised for a few rate hikes in 2022–23', according to many economists, insurance shares like QBE might be well placed to benefit from the change.
That's what Lazard Asset Management portfolio manager Aaron Binsted said when speaking with Livewire recently, noting the insurance giant could be a major benefactor to an increase in rates.
Binsted estimates that for every 25 basis point jump in average interest rates, QBE's earnings are set to lift dramatically – with earnings per share (EPS) as high as 5-6% from that jump.
In other words, QBE's earnings are sensitive to changes in the interest rate cycle and could offer a return that is tied to a spike in rates – something most companies don't enjoy the luxury of.
Binsted might be onto something too, as, at a quick glance, when charting the three datasets of inflation year on year change, Australian interest rates and QBE shares together over the last decade, the dispersion is remarkably similar, as seen below.
QBE shares gained 24% over the last 12 months and have climbed a further 4% this year to date to now trade near 52-week highs.
