Investment Strategies
We Need To Talk About Inflation - Wealth Managers' Reactions
Whether it is a temporary rise or something more durable, recent data pointing to a sharp rise in consumer price inflation has seized attention of economists who for years have been used to a world of tame price pressures for many consumer goods and services. How does this influence asset allocation?
Inflation is haunting the financial markets again. No longer just
a memory of the 70s and 80s in developed countries, consumer
price inflation appears to be gaining ground. Of course, the rise
in real asset prices after the massive central bank money
printing post-2008/09 was a form of inflation. But prices paid at
the shops appeared – at least most of the time – to have been
relatively well behaved. Cheap goods imported from China and
other parts of the world, coupled with the deflationary impact of
technology and globalisation, kept a lid on matters.
But the years of tame CPI may be over. The disruption caused by
lockdowns, and the further heavy public spending to handle the
results, appears to have reignited the CPI. UK data last
week for April showed that consumer price inflation rose by 1.5
per cent in the 12 months to April 2021, up from its 0.7 per cent
growth rate to March; on a monthly basis, CPI rose by 0.6 per
cent in April 2021, following a 0.3 per cent increase in March
2021. The figures are a way off from the double-digit numbers of
40-plus years ago, however.
Other numbers from the US have also pointed towards rising price
pressures, of course. The US CPI jumped by 4.2 per cent in April
compared with the level one year ago. This is the highest
consumer inflation rate since 2008.
What advice should wealth managers give clients about inflation?
How should HNW individuals hedge against it, and what asset
allocation ideas make sense? Over the decades, standard responses
have been to hold more gold, to put money into certain equities –
which tend to (mostly) outperform bonds in an inflationary
environment, and other hard assets such as fine art.
At some point the period of ultra-low/zero interest rates will
come to an end. A form of “financial repression” - forcing
people to save via equities instead of cash – can over time erode
capital and distort economies. As or when interest rates rise,
some of the yield-chasing behaviour of wealth management clients
will have to adjust. A period of very low borrowing costs has
been associated with a boom in private market investments such as
private equity. How might these areas be affected when rates go
up?
Here are some reactions to the figures last week. We intend to
keep monitoring this emerging macro-economic story in the weeks
ahead. To comment, email the editors at tom.burroughes@wealthbriefing.com
and jackie.bennion@clearviewpublishing.com
Royal Bank of Canada
We think much of the inflation spike is a short-term phenomenon.
The annual inflation rate plunged to almost zero per cent at this
time last year when the economy was shut down, and has rebounded
sharply this year as businesses have reopened. Once we are past
the April, May, and June period when prices last year were
falling, the year-over-year comparisons should be less extreme.
The question of how long “transitory” inflation will last is more
difficult to gauge. The longer it lingers, the greater the risk
that the Federal Reserve will shift away from its
uber-accommodative monetary policies. We think this will take
some quarters to convincingly sort out. This could keep equity
market volatility and pullback risks elevated for the time
being.
But the challenge for the overall US equity market is that the
inflation-vulnerable and valuation-stretched tech sector
represents a much bigger share of the market than it used to: 26
per cent of the S&P 500 today versus 17 per cent in 2010. As
long as inflation jitters are front and centre, institutional
investors may be inclined to ratchet down their tech exposure, at
least temporarily. To us, this means more adjustment time for the
market as a whole, which could include additional volatility and
rotation between sectors.
Anthony Willis, investment manager in the Multi-Manager
People team at BMO Global Asset Management
Globally, we have seen plenty of evidence of inflation (not least
in asset prices) but also in the real economy as evidenced by the
US CPI numbers, the Chinese PPI data and the comments in the PMI
surveys. We are in a period where financial markets are going to
be regularly challenged between focusing on the positives of
stimulus and strong economic growth as economies rebound, and the
consequences of that economic rebound for inflation and
potentially interest rates.
The central bankers have continued to push back on the potential
for rate hikes, with various members of the Federal Reserve
reiterating their expectation that higher levels of inflation
were transitory and would ease back towards their 2 per cent
target later in the year. Fed Vice Chair Richard Clarida said he
was surprised by the US CPI reading but that he expects inflation
“to return to or perhaps somewhat above our 2 per cent longer-run
goal in 2022 and 2023” with this outcome “entirely consistent”
with the Fed’s policy framework. His colleague Raphael Bostic
said he was “expecting a lot of volatility at least through
September” on inflation readings as transitory and base effects
work through the data.
The US Federal Reserve will likely stick to their “transitory”
narrative for several more months, but a continuation of the
elevated data will likely continue to see financial markets
reacting with volatility and testing the Fed’s resolve. The
sensitivity of financial markets to rate moves was highlighted by
the brief sell off last week after former Fed Chair and current
US Treasury Secretary Janet Yellen said “it may be that interest
rates will have to rise somewhat to make sure our economy doesn’t
overheat”. Yellen later clarified her comments to emphasise that
she was not predicting or recommending that rates increase, nor
is she expecting inflation to be a problem. All the same, the
market reaction highlighted the sensitivity of risk assets to
comments on rates and inflation; something we will likely see
repeated many times over the coming months.
Hinesh Patel, portfolio manager at Quilter Investors, and
Richard Carter, head of fixed interest research at Quilter
Cheviot
Patel: While much of this spike in inflation is
due to the easing of restrictions and rising oil prices as demand
is switched back on, this is ultimately bad inflation. Price
rises are squeezing households but where it goes from here is
difficult to tell. The data is noisy and will be all over the
place or at elevated levels for months to come. As such, the Bank
of England will not be compelled to act until it is sure a higher
level of inflation is becoming sustained.
It is going to be difficult to tell when the BoE will buckle and
reduce its stimulus and remove the quantitative easing that
markets have become so addicted to. Investors will need to watch
their moves and messaging carefully to help them work out how
markets might respond. But investors need to look through the
inflation numbers and assess the quality of businesses and their
underlying models before investing in them. Those built on strong
foundations, which have built up competitive positions will be
the ones that will succeed in a robust inflationary
environment.
Carter: “Despite the doubling of the inflation
print in April, the Bank of England won’t be too concerned, yet.
A significant part of the increase in inflation is due to the
base effects versus last year when we went into lockdown and
energy and petrol prices fell considerably. The BoE will expect
this bout of price increases to be transitionary, and one that
will likely resolve itself over the next six months as the
economy re-opens.
The risk, however, is that higher inflation expectations become
ingrained among consumers and producers and we start to see wages
increasing substantially as well. At that point, it is harder to
argue that the inflation is transitionary and the BoE would have
to react. As always, investors should have one eye on inflation
risks and hold some sensible hedges as part of their diversified
portfolio.
Guy Foster, chief strategist at wealth manager, Brewin
Dolphin
Considering the implications for policy, rising oil prices have
driven inflation higher. Future months will see some reversal of
previous price cuts, but there remain few sources of enduring
price increases for the Bank of England to fret over. In contrast
with the rest of the world, the absence of the big giveaway
stimulus seen in the UK, and the cautious approach to reopening
the economy due to the Indian COVID variant, mean inflation will
remain weaker than in the US.