25 May 2021
Fixation on inflation
Last week, equity markets continued to echo the rhythm of recent months. The focal point for investors was the news about growing inflation, and prices were somewhat more unstable following evidence that inflation is indeed on the up, as the efficacy of vaccination programmes means that economies are able to reopen. US and UK stock markets closed the week marginally lower, although the US S&P 500 Index remains close to its personal best.
The likelihood of higher inflation has been at the forefront of the news over the last few weeks. According to recently released data (see ‘In the Picture’ below), UK inflation more than doubled to 1.5% in the 12 months to April, while consumer prices in the US increased by 4.2% over the same period. The prices of lumber and other commodities have surged recently, as the global economy has begun to open up again and demand has rocketed.
Investors are currently preoccupied with the question of whether today’s higher inflation will be a short-term occurrence, or whether it will continue its upswing to the point where central banks across the globe will have no option other than to raise interest rates. The range of such support from central banks has been a plus for asset prices throughout the coronavirus crisis – helping to support markets since they were accelerated last year.
Johanna Kyrklund, Chief Investment Officer at Schroders and Manager of the St. James’s Place Managed Growth fund, commented:
“We don’t have a crystal ball as to what’s around the corner, but as investors we just need to assess the range of probabilities. And it’s clear that there has been a shift in the balance of probabilities compared to when the positive vaccine news emerged in November. Since then, both the MSCI World and S&P 500 have risen.”
“So, the potential upside remaining has probably shrunk, while the potential downside has grown. The odds aren’t as attractive now, but it’s too early to be overly defensive. There is no recession on the horizon; you need to stay invested and you can’t sit in cash.”
Wednesday last week saw the Federal Reserve release the minutes of its most recent meeting on the matter. According to the publication, its members believe that the bank should set about discussing “a plan for adjusting the pace of asset purchases”. Perhaps a sign of reassurance that the US central bank is in no rush to slash its support?
The power of portfolios
Naturally, fund managers take a range of future possibilities into consideration when building their portfolios, and a period of higher inflation is just one such scenario to account for when selecting which investments to make. Hamish Douglass, Co-founder of Magellan, which manages the St. James’s Place International Equity fund, thinks that his portfolio is well-placed to tackle a new investing environment, for example.
He anticipates that inflation will pull on the share prices of ‘cyclical’ businesses, which are prone to perform well in times of economic growth. Plus it may be a drag on the more speculative stocks too (for instance, innovative technology businesses) – the share prices of which have flourished over the last year.
“Around 50% of our portfolio in invested in defensive, high-quality assets. That could be businesses like Nestle and PepsiCo, or it could be McDonald’s. Those assets tend to do very well when markets get scared. It’s why, when markets go down, our strategy tends to protect people’s capital so well. It hasn’t been the best place to be in the past four months, but I’ve got a lot of confidence that the structure of our portfolio will give a lot of resilience.”