Last week’s headlines around the U.S. inflation rate jumping to 4.2% year-on-year to April furthered a wobble in financial markets, with investors concerned on the propensity of future rate rises to combat rising inflation. The initial reaction appeared to be over-cooked however, as markets had recomposed themselves by weeks end.
The fact remains that after decades of relative insignificance, inflation is suddenly commanding global attention. ‘Suddenly’ is perhaps not the right word to use, in that the inflation spike that we are currently witnessing has in fact been talked about – and expected – for months, especially when we consider the amount of stimulus that has been pumped into markets (vis-à-vis the corresponding increase in the money supply i.e. all the more money to spend with).
Why are markets concerned about inflation?
If inflation were to become a permanent fixture, interest rates rises would surely follow. This would have a domino effect across the economy as debt servicing would become higher, input costs would rise (prices would go up for the end-consumer) and there would be a gravitational pull on shares prices. Tech stocks appeared to take a larger hit on last weeks’ inflation news, because that would clip their future earnings – some of which are yet to become profitable. To give you an idea of the added sensitivity here, just five Tech stocks make up one fifth of the value of the S&P 500.
So what’s causing these inflation wobbles?
Quite simply, it’s a good old-fashioned case of too many post-COVID dollars chasing too few goods. ‘Base effects’ are at play too, where the increase in demand is being measured against an extremely low base i.e. when COVID first hit the global economy (March/ April 2020).
Trillions of dollars of stimulus continue to work their way through the plumbing of financial markets. Successful vaccine rollouts are giving people and businesses – and their wallets – more confidence to go back out there and spend.
The resultant boom is causing bottlenecks via supply-side disruptions failing to meet the ensuing demand.
With many suppliers and retailers winding back their stock and inventory during COVID, many are struggling to keep up with the post-COVID demand. International shipping is no exception, with both cost and time factors rising exponentially. Add rising commodity prices into the mix, and some would argue that we have a perfect storm for inflationary pressures.
Labour markets are struggling too. In April, the United States underwhelmed with just a 266,000 increase in reported jobs – a lot less than the anticipated (and needed) $1M + new jobs. Closer to home, and in Australia, we saw SEEK (an online job agency) report a record month of job advertisements in its 23 year history for the month of March. Also to note however, was that it was also SEEK’s lowest month of job applicants since 2012.
Is inflation really a bad thing?
Yes. And no.
As with most things in life, the key is moderation.
A moderate amount of inflation is good in that it helps a growing economy keep up with itself – it keeps the economy ‘in-check’ and ‘on-track’ across many economic indicators such as productivity and wages growth. It also encourages investment, as investors ‘hedge’ against the time-value of money i.e. a dollar tomorrow being worth less than a dollar today. Over the longer term, equities have been among the best hedges of inflation.
Too much inflation is bad, and for those of us keen on history, you’ll possibly recall those B&W photos in our history books of children in the Weimar Republic playing with kites made of worthless German paper notes. Hyperinflation had set in in the post-war period as the German economy struggled to absorb (solve for) its war-time debt.
Back to the future, and the developed world has traditionally targeted a long-term average inflation rate of between two to three per cent – however, inflation has been fairly absent across the past decade. In fairness, the developed world could do with a sprinkle of inflation. Wages growth has been stagnant, and that’s a key sign of progress for any economy. Where we respect that higher wage and input costs impact bottom-lines, we also acknowledge that higher productivity and revenues will increase the bottom-line further. It’s a delicate balance.
To quote the ‘Financial Times’ (UK) over the weekend; “at stake is one of the most remarkable rebounds in financial history, which has seen equities and other risk assets leap from one all-time high to the next thanks to historically low borrowing costs”.
What to expect next?
It’s important to note that Central Banks in the developed world – including the Federal Reserve, the Bank of England and the Reserve Bank of Australia – have made it clear that they are willing to let their economies run hot before they will even think about thinking about increasing interest rates (to paraphrase Jerome Powell, the Federal Reserve Chair) – so as to allow their economies get back on their feet post-COVID. They are looking through this ‘transitory’ inflation as a result.
It is likely that as the post-COVID economy recovers, and as global supply-chains and labour markets resolve themselves, that we may see further ‘transitory’ spikes of inflation.
The question on many investors minds is whether this transitory inflation will turn into something more permanent. Should inflation take-off and become a real concern, late-to-the-party policymakers may have to combat it with an even heavier hand.
As always at Bastion Financial Group, we continue to monitor the financial, economic and geo-political world around us, and how it relates to our clients’ portfolios and strategies – and we navigate them with you all.
Read here for more Bastion articles: https://www.bastionfinancialgroup.com.au/news/authored-and-published-articles
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Bastion Financial Group specialises in investment management and holistic financial planning advice to high net worth families, professionals and business owners. We utilise asset allocation, proven research based methods, a focus on education and decades of experience to help clients minimise the risk and stress of creating and managing wealth. We are Certified Financial Planners and active members of the Financial Planning Association of Australia (FPA). Our Advisory team can be contacted on;
David; david@bastionfinancialgroup.com.au or (08) 6225 5150 or 0407 770 782
Naomi; naomi@bastionfinancialgroup.com.au or (08) 6225 5150 or 0413 917 698
Important information
This article has been prepared by Bastion Financial Group Pty Ltd., Authorised Representative(s) of Godfrey Pembroke Group (ABN 38 078 629 973), an Australian Financial Services Licensee, registered office at Level 2, 26 Brisbane Avenue, Barton ACT 2600.
Any advice in this document is of a general nature only and has not been tailored to your personal circumstances. Accordingly, reliance should not be placed on the information contained in this document as the basis for making any financial investment, insurance or other decision. Please seek personal financial, tax and legal advice prior to acting on this information.
Opinions constitute our judgement at the time of issue and are subject to change. No member of the Godfrey Pembroke Group, nor their employees or directors, gives any warranty of accuracy, nor accepts any responsibility for errors or omissions in this document.
