Kohlberg Kravis Roberts & CO. (KKR)’s mid-year update echoes the sentiments of many other equity analysts—the cycle is different than past ones—and it’s time for investors to rethink how they are positioned.

“Looking ahead, we are now firmly of the view that the macroeconomic narrative will soon shift from a singular focus on the impact of inflation on the global capital markets to one where investors are surprised by how unwelcome inflation adversely affects corporate profits,” the June 2022 report says.

Specifically, while inflation from food, oil, and services continue, KKR sees opportunities in security, pricing power, decarbonization, collateral-based cash flows, and innovation, as those themes rise above what KKR deems the “noise” of unsettled markets.

So what are the shifts caused by these inflationary periods? One major change is the breakdown of the relationship between stocks and bonds. Traditionally, bond prices rise when stock prices fall, but data using monthly total returns of the S&P 500 and Barclays U.S. Aggregate Index indicate a changing of the guard. As the year-over-year consumer price index has increased overall, the rolling 24 months stock-bond correlation has changed from negative to positive—showing bond and stock prices are rising together, and the former is serving as an inadequate hedge against the latter. And according to Bloomberg, while Treasurys and the S&P 500 have historically performed inversely to each other during bear markets, that is not the case today.

In KKR’s eyes, the fact that bonds can no longer serve as diversifiers to be paired with equities means that investors must consider adding different types of investments to a traditional 60/40 mix.

Notably, analysts support credit, specifically shorter-term mortgages, over equities. Should investors still allocate funds to equities, KKR sees opportunities in sectors like hospitality, events, financial services, wellness, and beauty due to the possibility that services inflation could surpass goods inflation. Therefore, service providers that have pricing power should see increased earnings. Analysts also pick oil as a notable commodity to invest in the short term—KKR forecasts oil to be $115 per barrel in 2023, compared with the consensus at $91.

While there are still expanding opportunities for growth, KKR still cautions against certain trends. For companies with a limited ability to pass through labor and input costs, earnings could suffer.  An emerging area of concern is also non-premium consumer discretionary goods and premium consumer staples.

“We think that food, energy, and shelter inflation will force most households to cut spending on nice-to-have categories, putting pressure on the discretionary goods and name-brand consumer staples that were beneficiaries during the pandemic,” the report said. “The current backdrop will make it much more challenging for these companies to pass along higher input costs to their target markets.”

Despite new approaches to asset allocation that are needed, a key constant the report emphasizes is the need to stay “thematic.” Despite changing structural forces, some themes including security and innovation are still intact or strengthened by the current environment. KKR also remains bullish on data and transportation—sectors that thrive in good times and bad.