Inflation: Transitory or structural? Either way investors can prepare
As inflation data releases and headlines start to gather momentum, investors could be forgiven for thinking drastic action in their portfolios is required to weather the storm of higher prices. Furthermore as market commentators debate if it is indeed simply transitory as professed by the FED, or the start of a longer period of structural inflation, the temptation grows to attempt to play one scenario or the other. For the moment, consensus remains that the current flurry of higher readings is temporary and in line with a concentrated pick up in consumer demand as the global reopening gathers pace that will eventually fall back in line with longer-term levels. As comforting as this may be, there is also the possibility that the unique nature of the ‘voluntary’ pandemic recession may not play out as previous recoveries have: the labour shortage may be prolonged (as a result of people dropping outof the workforce altogether), personal savings remain high (pointing to further demand) and central banks’ plans to let inflation run hotter in the short-term may have unintendedconsequences…
As portfolio managers, rather than economists, the investment team at Banque Havilland regard protecting client wealth as the number one priority and that means constantly considering inflation even when it is not apparent or making headlines. We have long felt that the low rate/high stimulus environment that existed pre-pandemic meant that low inflation was not a given, despite the long term trends of technological advance, globalisation, de-unionisation etc, and as such we embed various inflation hedges within our client’s portfolios. As ever, a sensible, diversified multi-asset portfolio is the best way to preserve cash over the long term.
Firstly, as we have seen in recent months as the inflation narrative has taken hold, growth stocks with more distant profit horizons can be vulnerable to higher bond yields – and as traditionally investors would look to growth stocks to outperform inflation over the long term this is a problem particularly in light of stretched valuations. Cyclical and value companies have already benefitted from the reopening trade, with commodities especially surging so it may be that many of the gains have been realised now, and as such we prefer a blended,valuation conscious approach rather than an out and out bias to growth or value equities. Certainly we at Banque Havilland are cautious of securities that derive much of their valuation from earnings far into the future given their sensitivity to inflation expectations, and therefore we look for companies with pricing power, able to withstand rising costs and competition and which are able to sustain their margins in order to provide added protection to our client’s portfolios. This also points to the importance of a selective approach to equites, in identifying granular success stories whose profits outstrip inflation rates.
Precious metals are a permanent fixture within our multi-asset portfolios, with the historical properties of Gold as a store of wealth being a key reason for this.
While a proven inflation hedge, investors need to be aware of the vulnerabilities in a rising real-rate environment, as assets paying no yield become relatively less attractive, though with central banks expressing reluctance to meaningfully increase base rates as the world recovers from Covid this may not be as relevant.
Nevertheless, the uncorrelated relationship of precious metals with bonds and equities is an essential diversifier. Gold and Silver can also sit nicely alongside a holding in industrial metals, which is an obvious beneficiary as global economic demand increases in an inflationary environment. While bonds are not the most attractive asset class at the moment due to the prospect of inflation and higher rates, short-dated Treasuries offer diversification properties to equities, and we always include an allocation to inflation-linked securities such as TIPS and UK Linkers to help our client’s portfolios keep up with real returns. It is important to reconise that none of these positions on their own can be sure to offer protection against higher prices, and much will depend on the action of central banks, but with a portfolio prepared in the right way investors do not have to panic.
Jonathan Unwin
Deputy Head of Asset Management and Advisory at Banque Havilland S.A. – UK Branch
( source: Citywire NMA )
