Inflationary pressures will be giving investors food for thought, says Giles Coghlan, chief currency analyst, HYCM.
Whatever your opinions on monetary policy, inflation has been dominating the news agenda in recent months.
Although the UK economy is reported to be growing at the fastest rate in 80 years, according to some estimates, news at the beginning of August that inflation had overshot the Bank of England’s (BoE) forecasts for three successive months has troubled economists and investors alike.
In particular, ex-BoE chief economist Andy Haldane has been a vocal critic about the central bank’s decision to keep quantitative easing policy as is, and was the only member of the monetary policy committee (MPC) to vote for a tightening of policy. This view stands in great contrast to the more dovish mentality typically taken by the BoE’s MPC members.
More recent figures have since shown that UK inflation is back on track, however, the jury is still out as to whether we are in for a prolonged period of high inflation. Data from the other side of the pond has revealed that US consumer prices have surged by 5% in the year up until May. As such, investors might be concerned about how they can manage their portfolios effectively should this trend continue.
Here are some suggestions:
Staying ahead of the curve
The inflation debate is only just heating up – and it will rage on for many, many months yet. As such, it would be wise for investors to pay careful attention to central bank statements and consumer price indices before making any radical changes to their portfolio. Both of these resources can often offer a glimpse into the bigger picture.
For example, reading in between the lines of a BoE statement, say, might offer some hint as to when the central bank will begin tapering. Likewise, a consistently rising consumer price index might ward investors away from growth stocks.
In any case, investors in the UK should head to the Consumer Price Index (CPI), or the Harmonised Index of Consumer Prices (HCIP) for answers. In the United States, the most widely followed indicator is also the Consumer Price Index (CPI), which points towards the cost of transportation, housing, healthcare, retail prices of goods, and other services.
It is also important to note that each central bank will have its own target rate of inflation – investors should monitor how far off the bank is from missing or overshooting these targets. Rising inflation in New Zealand, for example, has been enough for the Reserve Bank of New Zealand to project an interest rate hike this year and four hikes in 2022. This was after inflation spiked above the 1-3% target hitting 3.3% year on year.
Does gold shine against inflation?
Even the most cool-headed investors will be wary that a long period of inflation will bite into the purchasing power of their money. Conventional wisdom is that bonds fare poorly in this environment, meanwhile assets like commodities, property and precious metals might offer a more attractive outlook.
To delve in a little deeper, investors will often look to gold as a ‘safe haven’ asset during inflationary period. While there is some truth to this, this mantra might need further thought. If this were truly the case, then surely, we would not see so much fluctuation with the price of gold.
Here, it is important to note the fact that gold will give no interest for holding it. As such, when witnessing economic strength and stability, investors will often sell gold in order to buy riskier and more profitable assets. All that said, when interest rates are low, this is good for gold.
Keep duration in mind
Away from precious metals and commodities, a key factor for investors to bear in mind is duration. If money in the future is worth less as a result of rising prices, it stands to reason that this can hurt the value of investments like growth stocks, which have cash flows that go far out into the future. With growth stocks in particular, an inflationary environment can cause the future profitability of these companies to falter, placing their expected earnings in peril.
For other asset classes, inflation might not cause too many problems. Take value stocks, for example – these assets have a higher intrinsic value than their current trading price and will, more often than not, outperform growth and income stocks. Here, investors should look to mature and better-established companies with strong current free cash flows – in short, the kind of companies that have always done well. These cash flows may lessen over time, but this will largely hinge on whether you are taking a long- or short-term view of the market.
Ultimately, inflationary pressures will no doubt provide some food for thought for investors, who should tread carefully before making any drastic market moves.
