Whither Inflation?
Inflation, in whatever form, favours the few – those who are well prepared.
Rhythms dominate our world: natural and man-made. Even in our current world of suspension – where most beliefs and rules are suspended - the pressure of a cycle will rule. The ebb and flow of the economic system will see the return of Price Inflation as we move from Asset Inflation.
Inflation – not always/often positive
In of itself, Inflation is a natural part of the economic cycle. Historically, Inflation matched with growth has proven to be a good thing for economies and societies. Yet, as with any dynamic, it is a question as how to control this formula.
Britain’s Andrew Haldane speaks of “holding the tail of the Inflation Tiger”. Trust in institutions and their leadership is at an all-time low. Metrics are questioned, unreliable. So how credible are the pronouncements of central bankers. The Valley of the Economists seems filled with the blind. The ‘Philips Curve’ tinkerers of the 1970s gave us the spectre of stagflation: no growth coupled with double-digit inflation (15% in the US). Margaret Thatcher opened the inflation box; and unleashed a Pandora’s storm, which took sclerotic Britain along an uncertain path of double-digit unemployment and eye-watering interest rates (21% at their peak). The partial transformation took nearly a decade.
More to the point of ‘now’; BrExit Britain is no longer the force, nor centre of the world, it was. The Inflation risk is American and all will be affected by it – including the Chinese Dragon.
Reset
The current concerns with regard to “yields” has seen US rates climb from 0.5% to over 1.6% in a short period of time: maybe a ‘bubble’ of its own kind. This development has helped herald the long-predicted reset of the Tech-dominated equity markets. The long list of monetary policy missteps of the last decade (aka QE, negative interest rates, and other forms, as well as questionable Covid responses) may have provided a balm to an injured world. They have reduced price inflation but not asset inflation.
Furthermore, other effects such government and regulatory actions have debased the economy and money. The days of relatively safe and secure bank savings account of 3-5% have been consigned to the past. Market liberalization and ineffective regulation (however light the touch) have not as yet proven to be beneficial. Ordinary savers and their pensions (the bedrock of the capital markets) have been led inexorably into the equity markets, the only show in town; inflating valuations further. Savings rates are less than 100 basis points. Redefining metrics (such as manipulating borrowing costs and maturities) may ameliorate factors but not resolve them. Witness the Greece sovereign debt crisis; taken off the boil, but still simmering. Institutional policies and actions continue to erode the ‘notion of investment risk’, and ‘risk premium’.
The Inflation potential; measuring the development of Money Supply (in blue) versus Nominal GDP (in orange) reveals the gap that will eventually need to be filled (as shown by the red mark in the chart below).
The Pandemic Equity Panic of March 2020 was merely a speed-bump on the course of the hugely inflated value of the equities. There are few alternative asset classes that can attract the vast ocean of investment funds. The winners have been corporates and those citizens who can invest at scale in the equity market. If “sub-prime” was the by-line of the 2008 crash “corporate junk bonds” may well be that of the possible mid-20s crisis looming. The annual increase in US ‘broad money’ supply has increased from 5 to 25%. The rising US Housing market demands consideration; as house sales have grown at a double digit. Capital sending is up in a race to “digitise everything”. The USD$ 600 billion stimulus income programme has seen US personal disposable income rise by 11% in a month.
Furthermore, the recent USD$ 1.9 trillion Biden pandemic aid package threatens to fuel the flames of inflation. Apparently, there is the prospect of a further USD$ 2-4 trillion for Infrastructure investments on the way. The huge assumption is that ‘Growth’ will follow. The “Guns or Butter” saga of the 1960s may be set for a re-run.
One cannot assume the near future will be like the recent past. Whither inflation? The Fed’s target remains +2% annually; a laudable, tried and tested level of the past. But how to contain it, especially in the current context of suspension?
It is not all ‘doom&gloom’, but a weather eye needs to be cast at the grey horizon.
Where to run; where to hide?
The traditional safe-havens are clear; but even they have become debased.
Precious metals. But the traditional relationship between Gold and Silver seems out of kilter. Also, the important Copper/Gold relationship may be broken.
Commodities. Yes, crude oil prices, at low levels from the preceding decade may rise partly as a capital refuge; but what of the increasing effects of the Green revolution on fossil fuels?
Consumer goods. The classic Tobacco, Food and White Goods sectors are no longer the giants they were. The automotive industry is just entering a phase of fundamental change.
“Value stocks”. While some individual ones in Energy and Finance may be attractive others will be subjected to the possible dynamics of falling asset prices and credit squeezes.
Crypto-currencies. Despite the merits of block chain technology, this drama is ongoing and it remains uncertain if Bitcoin has entered the real world or remains the stuff of fiction. Is Bitcoin digital gold? The rise of crypto-currencies, five-fold in the last twelve months, seems more a reflection of inflationary and speculative forces rather than a panacea.
Property. Yes. But what of the large stock of current half vacant and empty new builds of offices and retail shops. Which property developers and associated banks will fail?
But in the post Pandemic clawback, one is likely to see a raft of taxes imposed. These fiscal responses could see the imposition “exception” or “surplus” profit tax (last used after World War 1); along with increases for stamp duty and inheritance rates. Definitional changes may also be made; placing the burden more fully on fewer, yet wealthier tax payers. Who knows, Internet access may be taxed. “Universal Credit” may morph into something more Orwellian; perhaps replacing current state pension schemes, effectively defaulting on sovereign debt by annualizing it.
Other effects will continue to reverberate. Currencies will gyrate: witness the Cable climb from $1.20 to its present $1.40. Many corporates will fail, based on their junk bond portfolios. (Re)nationalisation of essential services; has been a policy reaction of past decades. Swelling ranks of unemployment. Again, all well-known stages along the natural cycle
Portfolio considerations
For those thinking to be prepare a portfolio in such unsettled times: land-based assets, using leverage (as inflation favours the solid, credit-worthy borrower) would seem an unexciting but safe harbour. Specifically, in the US, such tickers as: AMKR, HFC, MSGN, RKT, SXC, TAP & certain REITS along with selected Energy and Financial stocks may be worth considering. Also, an increased use of derivatives, such as covered calls (www.thewrittenfund.com), may be a sensible approach, along with direct investments in stocks.
In these times of excitement, ‘safe’ has its appeal.
So perhaps less of ‘to the Moon’ and more ‘to the country’ as Market rotations and gyrations continue.
RISK WARNING
The views expressed are those of the author alone. Investing in any financial instrument carries risks. Your capital may be at risk. Certain investments maybe long term and may not be readily realisable. Please consider all risks before investing. Gate Capital Group Ltd is authorised and regulated by the Financial Conduct Authority (FCA Number 189170).