Inflation has crept up the list of concerns for investors and Investment Managers alike.
Those with long memories, or who have studied the 70s and early 80s, will understand how the spectre of inflation can strike fear into rational people. However, it is worth noting that rampant inflation has not been a serious problem in the UK for over 30 years now.
It is no coincidence that the period coincides with the growth of Globalisation and the accelerating development and adoption of new, often disruptive, technologies in most walks of life. Both themes have a deflationary impact on prices. An ageing demographic and, with it, a propensity to save rather than spend acts likewise.
It became clear in the Financial Crash in 2008/09 that the deflationary impact of these themes kept inflation at bay even as Central Banks went on a money-printing spree the likes of which had not been seen before in peacetime; a spree trumped barely more than a decade later in the pandemic.
So, will Globalisation and Technology remain in the ascendency over the inflationary fears of money printing?
Inflation will go up in the UK. Not directly because of money printing and near-zero interest rates but simply because it is a year-on-year measure of the price of goods and services, so will shortly be comparing to prices at start of first lockdown. Any recovery, however tepid, will be seen in some inflation from such a low starting point.
Central Banks and Governments have signalled that they will tolerate inflation above target (2% in the UK) rather than put the brakes on and risk upsetting the recovery. After all, what they will not say out loud is that inflation reduces the value and therefore size of the huge sovereign debts being amassed daily.
The key for investment is inflation expectations. Yes, inflation will rise in 2021 if, as anticipated, the pandemic eases and economic activity increases. But that is unlikely to lead to a sharp rise in wages with unemployment set to increase as furlough is tapered or removed altogether. This is not a ‘genie out of the bottle’ moment for now.
We are not complacent. Portfolios are positioned for a bit of inflation. In such a scenario, value (cyclical) stocks and real assets tend to perform relatively well. Infrastructure has long been an asset we are happy to hold and the nature of the long-term returns tend to be ‘inflation-proof’.
Growth stocks, many of which have performed well in the pandemic may be a little less attractive but remain part of the disruptive technology theme that is still keeping inflation at bay. A balanced approach is sensible.
In Corporate Bonds we have tilted our positioning more towards Strategic Bond Funds that have a broader investment mandate and can position themselves more flexibly for a rise in inflation expectations.
For those casting back to the 70s and 80s and the inevitability of roaring inflation as a direct result of money printing, we cannot say with absolute certainty that it will (continue to) be different this time. But the markets are not anticipating it.
There is a measure used by Investment Managers to accurately reflect real-time inflation expectations – the 2yr/10yr yield spread on US Treasury Bills (the US equivalent of gilts). This is the extra yield that an investor receives each year for investing in 10-year Bills rather than 2-year Bills.
At times of high inflation an investor would need a substantially higher yield to protect against the inflationary erosion of their capital over ten years rather than two. The spread, having sunk as low as 0.6% last year, has risen to 1.2%.
That is a big move and tells us that inflation concerns are rising a bit. But investors are still settling for just 1.2% more return per annum for the next ten years. It is certainly not saying that markets are expecting inflation to be back to the level of the 70s and 80s.
Please stay safe and patient.