Inflation in context
21 July 2022
21 July 2022
It’s inflation day, with the the Office for National Statistics (ONS) publishing its latest estimate on the rate of growth for the past year. You'll more than likely be seeing many outlets publishing 'breaking news' with headlines such as "prices rise at fastest rate for 30 years."
Inflation will undoubtedly be incredibly important for investors over the next decade and beyond. The inflationary environment dictates which assets do well or badly, impacts the path of economic growth, and, most significantly, sets a hurdle which investors need to overcome to preserve the value of their cash.
On the 7IM Investment Management team, we spend a lot of time thinking about inflation and its consequences. We think that inflation is likely to be higher over the next ten years than it has been previously — bouncing around above 2%, rather than around 1%. That has vital implications for how investment managers think about portfolios.
Before I get to that, I want to try and put some context around 'inflation' – and the ONS report which came out today.
INFLATION ISN'T NEW
Technically, those headlines aren't wrong. The 12-month increase in UK consumer prices to March is the largest we've seen since 1992 – whether you’re looking at the CPI number (7%), the RPI number (9%) or the government’s preferred CPIH number (6.2%) – but that's not necessarily news.
Last month’s inflation numbers were also at a thirty-year high; as were January’s, and December’s. These figures have been rising sharply since the summer of 2021. The technical fact of "another new high" doesn’t really add anything to the existing picture.
Consumers across the country already know all about rising inflation. As individuals, we don’t need to wait for an 'official' number to know when our living costs are going up. We’ve all been to the supermarket, or DIY store, or airport, or petrol station. We’re well aware of the rising cost of energy across the world, and the increase in the energy price cap (not included in these recent figures) had been common knowledge for months. People have been making adjustments – some of them very difficult – already.
What the public knows, policymakers also know. The data has been clear for months. The ONS was already conducting impact assessments on the cost of living in January. The Bank of England has been increasing interest rates with the express goal of trying to rein in further inflationary tendencies in the economy. The government’s Spring Statement was almost entirely aimed at the issues surrounding the cost of living.
Companies are responding, too. The likes of Tesco, Sainsbury’s and BT have given their employees their most significant pay rises in years, and the National Living Wage has just increased by 6.6%, to £9.50 per hour.
This highlights that, while inflation is absolutely a key concern for all parts of the UK economy (and indeed most of the developed world), it’s not a new problem. It's been in the public consciousness for many months, and action is already being taken in all parts of the economy – whether that’s increased investment and innovation to address supply shortages, shifting consumer demand habits, or the changing interest rate environment.
INVESTING FOR INFLATION
Some of the recent pressures on inflation are likely to fade as we move towards the end of 2022, particularly those related to COVID-19 supply chain issues, and (we hope) the conflict in Ukraine.
We nonetheless believe inflation is likely to remain above 2% in the developed world, reflecting an increased level of demand fuelled by strong consumers, supportive governments and confident businesses.
Leaving the mushy malaise of the last decade is no bad thing. The scars of the financial crisis are finally healing, which should ultimately be a positive for the whole economy. Still, some asset classes remain quite far from pricing a new decade of higher growth and higher inflation.
The most notable winners of the last decade were government bond markets and US equities (especially the technology companies), while the laggards have been emerging market assets, alongside banks, and energy/mining companies.
Our portfolios favour the unloved equity assets from the previous cycle, and we’re seeing that the momentum has already begun to shift, with a long way still to go. We also keep our meaningful tilt away from bonds, which has already avoided a lot of the pain from rising interest rates. We believe there’s more to come, and prefer to use a basket of alternatives strategies to offer stable returns and defensive characteristics.
This document is believed to be accurate but is not intended as a basis of knowledge upon which advice can be given. Neither the author (personal or corporate), the CII group, local institute or Society, or any of the officers or employees of those organisations accept any responsibility for any loss occasioned to any person acting or refraining from action as a result of the data or opinions included in this material. Opinions expressed are those of the author or authors and not necessarily those of the CII group, local institutes, or Societies.