With all the recent media focus on inflation, we felt it was important to have our own viewpoint and to share that with our clients. As always, an analysis of inflation is not a simple thing with a simple answer. Over the course of this week, we will post a series of three articles that we hope will help you to understand our position and how we will adjust our investment outlook because of it.
First up, Peter Forrester will give you his overview of what inflation looks like in 2021. Later this week, we will enjoy the investment experiences of Alex Hammond-Chambers as a fund manager through the last period of concentrated inflation in the late 60’s and 70’s. We will end the week with the thoughts of our esteemed Advisory Panel who met last week – inflation was a hot topic.
We hope you enjoy!
Breakfast in Claridge’s
Back in the last millennium I had lunch with the salesman of a well-kent hedge fund manager. We were discussing inflation and he remarked that his measure of inflation was that the cost of breakfast in Claridge’s had increased by 40% in that year alone.
Ten years on, from a respected economist – inflation (then around 2% and falling) would increase in the next few years. Equities would benefit up to a level of 4% but progress would be problematic thereafter. He was over-pessimistic (or was it over-optimistic?) on the first: the second may soon test us.
So what is inflation? the price of gold? the RPI basket? Bitcoin? Wage growth? As Terence would have said, ‘quot homines, tot sententiae’ (there are as many opinions as there are people)
Is inflation intrinsically bad? Surely it oils the wheels of commerce: without it there would be no investors, no capitalism.
And is it merely an increase in price or its derivative – the exponentiality of that increase?
We should not be frivolous. Millions are being won or lost, reputations made and destroyed on the debate. For markets and investors it has become an obsession which, like many investment obsessions, may be transitory. How much damage will the obsession do along the way? Like Covid, once it is in the system it is near impossible to eradicate. So it is to be managed, not vainly avoided.
Few central bankers, let alone commentators, economists and consumers, have witnessed all elements of inflation at first hand. Even for seasoned ‘geriatrics’, current conditions differ from the 1970s and 1980s. This is not a time for analysis, extrapolation or modelling but there are lessons to be learned from the last generation. We need to respect the past but acknowledge the uncertainty of the future. It is a time for judgement, for breadth of thinking and – admittedly – for luck.
So how do we assess the new inflation variant? Growing demand without commensurate growth in supply leads to rising prices – to us, asset price inflation. Easier money leads to more affordability, greater spending power. Price increases are absorbed. We cannot deny that, worldwide, central banks’ largesse over the last twelve years has increased money supply and catalysed the spender, the investor, the speculator.
So far, inflation has mainly been seen in assets, evident clearly from property and share prices. They do not directly increase the cost of living, so wealthy investors have benefitted. But with greater spending power from wealthier investors, demand for assets has led to higher growth and higher raw material demand. Commodity prices like copper, lithium and cement have increased sharply this year, as their supply has dwindled while demand has increased. COVID has aggravated the position, not just in assets but in labour. Employees laid off or furloughed have found it both safer and more rewarding to stay at home. We are on the edge of wage inflation – both more visible and more destructive.
The relationship between inflation growth and higher interest rates is obvious. Less so between earnings growth and inflation. Conventional wisdom has it that growth stocks will suffer from falling profits in inflationary times, but how consistently will it benefit ‘value’ – for which read cyclical businesses? By definition their earnings are transitory and lower quality; they are often heavily indebted and less able to finance their growth. In contrast growth businesses with quality profits earned from secular trends have greater visibility and are more able to finance their growth.
This is not to deny that these companies are currently highly valued, more that the quality of their growth will become again be appreciated when the cycle turns. Over the long term they will be the more consistent, the more profitable and superior investments.
HF focusses on long term growth. We recognise the need for value as a countermeasure but in the last resort value and growth are two components in the quality equation.
And the growth investor must recognise that there will be air pockets. The massive fiscal stimulus evident worldwide will catalyse growth. But there could be a price – a crunching economic blow to curb inflation. The inexperienced investor and the herd instinct of human nature could play havoc with financial markets.
A final word on inflation. Prices will increase – whatever the measure – despite precautions. Over-analysis of inflation’s effects is wasted effort in our opinion. More worthwhile is the identification of decent assets that will – in time – ride out the storm. The nub of a sound investment is consistency of competent management and sound finances. If this can be maintained, breakfast in Claridge’s might yet be affordable.
Andrew Hamilton, June 2021
Financial Advice | Investment Management
The information contained in this document is for guidance only and does not constitute advice which should be sought before taking any action or inaction. The value of investments can fall as well as rise. You may not get back what you invest.
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