Market Musings 030922: What If… Inflation Fell Sharply?

3rd Sep '22 by Edmund Shing

12 comments 2264 reads

Market Musings 030922:

What if… inflation fell sharply?

Search for the chinks in the consensus narrative - that is where money can be made.

Summary:

The consensus narrative: Inflation is everywhere, and will be persistent
The causes of today’s inflation: COVID, employment growth, supply chains, Ukraine conflict
Sowing the seeds of lower inflation rates tomorrow: higher interest rates, renormalised inventories, lower demand
How could inflation fall faster than expected? Petrol/diesel prices fall, housing markets cool, unemployment rises, discounting of surplus goods
Investment conclusion: where to benefit, what to avoid

Podcast this week: Are we in a bull or bear market?

Will the mini-rally continue or could stock markets post further falls this year?
Has all the bad news been priced in?
In today’s morose environment, what hope is there for investors?
What evidence are you looking for before turning bullish on equities?
What are your favourite stock markets and sectors?

Recent (short) article: Talking Themes: Income from the corporate world

The consensus narrative: Inflation is everywhere, and will be persistent

The spectre of inflation haunts everyone, both households and companies, with daily reports of sky-rocketing energy bills, rising supermarket food prices and rising rents in major cities everywhere.

As investors, we need to focus more on how we think the future will evolve, as opposed to just what the current environment is today. No-one would claim that this is an easy exercise, but that essentially is what we are doing when we invest.

The causes of today’s inflation

There is of course no single cause of today’s explosion in prices across the board - there are several root causes. But we cannot lay the blame for today’s price shocks solely at the feet of the Russian President.

Let’s lay out some of these inflation precursors:

The COVID-19 pandemic, lockdowns and government + central bank response to lockdowns to prevent the global economy from melting down. The combination of government handouts (direct to households and companies, plus tax cuts and other forms of government support) and zero or negative interest rates (to stimulate borrowing for investment in growth) were very successful in spurring economic recovery post lockdowns. But perhaps too successful in encouraging demand, to the point where we have had too much demand chasing too few available goods and services.
The success in driving employment growth to new highs. The European Union registered its highest level of total employment in…

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Metatron

4th Sep '22

Most of the low inflation winners (insurance banks discount retailers energy efficiency) also seem to benefit from high inflation

Epsilon

To visualise the future direction of UK inflation, I think it's instructive to look at the CPI basket weights - the four largest categories sum to almost two thirds of the total:

As you yourself note Edmund, three of these four categories are those seemingly most exposed to price escalation:

"The combination of higher costs for housing via rents and mortgages, for energy and for food is obliging consumers to cut back on spending for everything else (so-called discretionary spending).."

So for me it's too early to be able to see an inflection point either in the inflation rate nor the pending slowdown in economic growth.

ken mitchell

5th Sep '22

Great article Edmund. It’s a shame that there aren’t far more readers, and that there isn’t more follow up for quality articles like yours like there is for the (also excellent) daily Small Cap Value Report. Not many people are going to reply unless readership increases and responses likely.

Other areas well worth considering now in addition to those you suggested include the following:-

Fund Managers. Some have fallen heavily but will recover when markets pick up again and maybe before. E.g Polar Capital Holdings (LON:POLR) with big dividend while waiting for that upside.

Investment Trusts. There’s so little interest in them here and elsewhere. Far better than Open Ended Funds and discounts have widened considerably.

e.g Biotech sector. Way off highs and these 3 Trusts at discounts to NAV around 8%. Biotech Growth Trust (LON:BIOG) 997p Worldwide Healthcare Trust (LON:WWH) £32.60 and International Biotechnology Trust (LON:IBT) 643p and useful 5% dividend.

e.g Vietnam via one of these 3 very successful Trusts yet all are on double digit discounts. Vietnam Enterprise Investments (LON:VEIL) 699p VietNam Holding (LON:VNH) 334p or VinaCapital Vietnam Opportunity Fund (LON:VOF) 501p.

e.g Private Equity Trusts where even those that usually trade at premiums like £iii £11.44 and HgCapital Trust (LON:HGT) 366p are currently on sizeable discounts. And other quality buys in the sector like Oakley Capital Investments (LON:OCI) 398p is on an extraordinary 36% discount to NAV!

Also worth considering are a range of big dividend paying shares like the insurers on Edmund’s list (e.g Aviva (LON:AV.) 419p and 7% dividend they promise to increase year in year. Same for Legal & General (LON:LGEN) 263p and 8% dividend. Also Chesnara (LON:CSN) 322p and up 16.5p today. 7% dividend and recently increased yet again and for, from memory the 18th year running!

There are plenty more but that’s enough for starters!

Madameski

Interesting article.

carvalio

Edmund, thank you for your weekly blog. It really is the highlight of my Stocko subscription.

Epitychia

6th Sep '22

Better to look at the last period of inflation in the seventies.

After about a year it becomes baked in, wages rise to compensate for past inflation, triggering another round of price rises.

Stage two is where wages anticipate higher prices next year, this causes inflation to start doubling and runaway inflation starts.

Stage three is people abandon cash and spend money as soon as possible, converting money into goods. This triggers hyper- inflation, money is useless, and barter takes over.

Always good to have some gold in your portfolio if only for diversification purposes.

Edmund Shing

ah you are too kind carvalio!

Tx Edmund

wolfspirit

I've just found this blog - nice to hear this perspective. I'll add it to my regulars! Thanks.

Bullsnbears

Hi Edmund, I really enjoy reading your insights and thoughts. Many thanks for posting.

Ponzy Mad-Hoff

Table published by Goldman (or maybe it was JPM) showing how different assets perform with high inflation

The Phoenix

Hi Ponzy did you happen to have a link to this document/report ?

Thanks

Andy

JCPr

Is the 1970s a good model for the current inflation? I think a closer parallel is 1919-20. Albeit back then the wars in the Ukraine had far less impact on the west.

Market Musings 030922: What if… inflation fell sharply?