Invest in inflation. It's the only thing going up.
Following the lockdown-related economic crash in 2020, governments and Central Banks worldwide injected vast liquidity amounts. This has helped drive a quick recovery in economic activity that has lifted risk assets to fresh all-time highs.
However, as solid demand meets a capacity-constrained world, inflation has surged beyond the levels previously implied by base effects. As a result, investors are preparing for a scenario where producer and consumer prices increase more persistently and eventually drag up interest rates.
This also confronts systematic equity strategies with a new environment. Most importantly, it is often assumed that the relative performance of the value factor is driven by changes in discount rates and was adversely affected by the low rate environment experienced over the past decade.
The argument rests on the observation that 'cheap' stocks are less sensitive to the discount rate applied in a Discounted Cashflow Model as their Present Value depends more on near-term cashflows.
In this paper, I study the empirical relationship between the relative performance of the value factor and changes in interest rates, inflation, and economic activity in the United States since the 80s. While the DCF model-based idea of interest rate sensitivity makes sense intuitively, there is only weak empirical support for it.
The performance of the value factor seems to be somewhat correlated to the path of real interest rates.
Nevertheless, this relationship is not very pronounced and highly unstable.