Bank of America believes this is the big turning point for inflation and rates. How to play it

Published Thu, Mar 11 20219:51 AM EST

After four decades, a sea change for inflation and interest rates is finally upon us as the economy reopens from the pandemic amid unprecedented monetary and fiscal stimulus, according to Bank of America's Chief Investment Strategist Michael Hartnett. And the bank believes certain industries and companies are better positioned for this new paradigm for their ability to squeeze profits from higher prices. "We believe we are at a secular turning point for both inflation & interest rates," Hartnett and a team of the bank's strategists said in a note Thursday. "We believe 2020 likely marked a secular low point for inflation and interest rates due to a reversal of deflationary secular factors, fiscal excess, and an explosive cyclical reopening of the global economy creating excess demand for goods, services and labor." Inflation expectations have turned much higher as prices recover from pandemic lows. Many believe the massive fiscal stimulus with a $1.9 trillion rescue package expected to be signed in to law this week could stoke inflation. Meanwhile, some say the Federal Reserve's open-ended bond-buying program could also lead to an overheating economy. Higher price pressures have been a top-of-mind issue for equity traders as inflation erodes the value of future company profits, and can cause a spike in Treasury yields. The 10-year yield surged above 1.6% recently from below 1% at the beginning of the year. "New central bank mandates, excess fiscal stimulus including UBI (Universal Basic Income), less globalization, fading deflation from disruption, demographics, debt…we believe inflation rises in the 2020s and the 40-year bull market in bonds in over," Bank of America said. "2021 is likely to see a jump in inflation on reopening, vaccine & policy stimulus." Equity playbook Bank of America broke down several ways for stock investors to position for the potential pickup in inflation and interest rates. Firstly, the bank recommended value and cyclicals which will benefit the most from an economic rebound from the pandemic-induced recession. Meanwhile, stocks with inflation-protected dividend yield also worth taking a look, the bank said. In terms of sectors, Bank of America looked at the correlation of S & P 500 sectors and inflation from 1974 to present. The bank concluded that energy and materials are the two areas of the market tied to high price pressures the most, calling them the biggest inflation beneficiaries. Energy is also the least labor-intensive sector, the bank added. The energy sector has been the best-performing group this year by far with the Energy Sector SPDR up more than 40%. Bank of America also screened S & P 500 companies that its analysts believe have the most pricing power and ability to expand margins at times of rising prices. The stocks include a few chipmakers — Nvidia, Texas Instruments and Broadcom — as well as consumer plays like Home Depot , Nike and PepsiCo. Energy dividend payer Exxon Mobil is also on the list. Other asset allocations The bank believes the turning point for inflation will also have profound implications for long-term asset allocations. Real assets such as real estate and commodities are poised to outperform financials assets, Bank of America strategists said. Real assets have shown the biggest correlation with inflation since 1950, they noted. The bank also believes the most optimal asset allocation in this new regime will be equal four parts of bond, stock, cash and commodities. "Assume lower returns across asset classes (+10% from stocks & bonds of recent decades likely to fall to 3-5% long-run returns)," the strategists said.

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And the bank believes certain industries and companies are better positioned for this new paradigm for their ability to squeeze profits from higher prices.