We had a great question on whether the current rally can continue. So, this month we look at inflation, and can the global rally last?
October Spotlight – Is inflation transitory, and will the global rally last?
Every year we get a new buzz word: this time around it seems to be “transitory”. The idea is that inflation will be high for a short while and then will drop down to more normalised levels.
It is clear now that certain elements are pushing up inflation, whether it is the demand for cars, airfares, hotels etc. In the UK as an example, it is estimated that the cost of UK holidays increased by 40% this year, and this is purely driven by demand.
In terms of goods companies ran inventories (stocks) low and demand is far outpacing supply, meaning prices go up and this pushes up inflation. The main point is that inflation can be driven by supply and demand, and as they settle then this inflation should drop back.
However, the area to watch is wage growth. We have seen evidence of lorry drivers being offered 40% pay rises. We can argue these are one-off payments but there is a ripple effect. In the US there are 10 million job vacancies and this puts upward pressure on wages. Many people in the US did better from Government payments and are not keen to rush back to the same jobs.
Companies are therefore having to pay more to get the right people, and there is growing evidence that they are more willing to pass on the increased costs to the customers because they believe they are willing to pay for it. Eating out is a great example of seeing this increase.
Additionally, global infrastructure creates a demand for jobs and the push to net zero increases costs etc. So, yes, the higher inflation we are seeing will likely drop back, but we could see average inflation rising to around 3 to 4% over the next decade, which would be higher than the previous decade.
It is hard to predict the future impact of this, but it is worth considering the following table as a ticking timebomb of higher inflation.
|Income (assume no increase)||Impact of average inflation of 3% over 5 years||Impact of average inflation of 4% over 5 years||Impact of average inflation of 3% over 10 years||Impact of average inflation of 4% over 10 years|
The table assumes someone receives a static income / pension, and what inflation of 3% or 4% would do to erode the value of that income over 5 or 10 years. Someone receiving £40,000 a year with no increases over 5 years would see the value erode by around 13.7% assuming inflation at 3%. When factoring in rising rates and increased tax then this creates the potential for concern and could lead to a slowdown in growth over the longer term.
Higher inflation means higher interest rates, and the assumption is this is a bad thing….but is it? The reality is that if interest rates were 2% and inflation 3%, that shouldn’t really trouble the markets in the short term.
Although we have seen significant growth in the US markets it is important to stop and reflect. Much of the global growth has come from goods, the service side still needs to recover. It is also worth reflecting those areas like old tech, energy, industrials, and financials have significantly underperformed, and there still remains pockets of opportunity. Equally, although US Growth has done well, regions like the UK, China, Japan, Eurozone, EM, and US value are relatively cheap.
The long-term outlook for China, Asia and EM remains very favourable, Europe is way ahead and at the forefront of the green economy which is a multi-decade theme etc. The point being that US Growth might drop back but on a global outlook there are still plenty of opportunities.
We should not be complacent and there are clearly risks. The Delta Variant (and others that will follow) is likely to slow the recovery and therefore elevated inflation could remain longer than expected. The Fed could move too quickly or too slowly for the markets. And we should expect increased volatility with markets as they try to digest news as it filters in.
In terms of whether the market rally can continue we think a more diversified approach is needed. Although US Growth has done well it is important to remember that not all parts of the market have done the same, so other areas may take over from the US. Could there be a market correction, almost certainly, when and for how long we don’t know but we shouldn’t be fearful because these always happen (look over the past decade). And finally, it is worth reflecting that as one fund manager said, we should not fear inflation in the short term but really focus our attention on the direction of monetary policy, where they believe the greater risk lies.
In summary, short term we should expect elevated inflation. This is likely to drop back but will likely be higher than in the previous decade. For those receiving a static income then higher inflation could erode the value over time, and this could slow long term growth. Higher inflation and rates should not impact returns in the short term as there remains opportunities across the globe, but it does not mean there won’t be volatility and even a correction, but rather than being fearful these could be opportunities!
Sources include but not limited to Financial Times, BBC, JP Morgan, Nomura, and De Lisle
Tracking the market
The S&P 500 has dropped back from its highs but remains up for the year. In September the FTSE was one of the best indices delivering a slightly negative return. The safe place to be was oil which was up nearly 10% in September, and up nearly 60% this year.
|1 January 2021||30 September 2021||Increase|
|1 September 2021||30 September 2021||Increase|
Sources of data: CNBC, Yahoo Finance & Reuters
What is in, and what is out?
Looking at 12-month performance to the 30 September 2021, the top ten performing funds include five energy funds with the iShares Oil & Gas Exploration & Production UCITS ETF up 103.70%!
At the bottom there are 8 gold funds with the ES Baker Steel Gold and Precious Metals Fund down -30.80%.
Gold was the haven in 2020 and now this has completely reversed.
Looking at Data from the Investment Association in Q3 2020 there was -£472 million in outflows from equities, at the end of Q2 2021 the inflows were £6,173 million. Fixed income saw outflows in Q1 2020 of -£4,770 million, in Q3 2020 the inflows where £4,586 million and this has dropped back to £3,226 million in Q2 2021.
In summary, we can see that Gold has underperformed this year and this is reflected in the performance of the best and worst funds. Equally when demand for oil dropped the price dropped, as demand increased so the price has increased and again this is reflected in the performance of funds. In terms of fund movements, as markets dropped in 2020 the move was to safe assets away from risk assets (equities). As markets have recovered more money has flowed back into equities. Of course, you could argue the best time to invest was when everyone was taking money out!
Sources of data: TrustNet, Investment Association
Talking shop with fund managers
September has been busy with around 15 fund manager meetings. Most of these will be appearing on the website shortly! We thought we should share some thoughts from different managers.
Nick Clay from RWC used this phrase, “when all are crowded together, looking to the stars….worth looking at a differentiated approach”. This was expressing the concern that assuming what has worked over the past decade will work over the next decade, could be a risky strategy.
Rob Burnett of LF Lightman expressed similar concerns that investors are less concerned about earnings, and everything is about the price and what investors are willing to pay. At some point price will matter and this could stall the mega share price rises we have seen with some companies.
Richard De Lisle of De Lisle Investments believes the environment remains favourable for big tech to keep growing but it will run hot (ever rising share prices), and that could lead to the seeds of demise.
Nomura Fixed Income Team explained that the real risk to markets in the short term is not inflation but the direction of monetary policy, and how the Fed are seen to respond.
JPM Guide to the Markets team believe the market has legs to run but sees greater volatility moving forward.
General disclaimer: The data has been sourced from external sources and although we have looked to ensure this is as accurate as possible, we are not responsible for data they supply. The view on inflation and the market is written in a personal capacity and reflects the view of the author. Equally the views under talking shop are those of individual fund managers. Individuals wishing to buy any product or service because of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made because of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.