Liontrust Views Autumn 2022 - Magazine - Page 5
views
John Husselbee
Just as Brexit and trade wars dominated sentiment in 2018/19 and
Covid took the reins last year, the macro story of 2021 so far, beyond
vaccination efforts, has been whether better-than-expected growth as the
world reopens might spark runaway inflation and how that could affect
recovery from the pandemic. This has meant a growing focus on central
banks, with their every word analysed for any signs of a shift in policy.
Inflation in the US has already crept above 5% year on year while
in the UK, the level has exceeded the Bank of England’s 2% target
for the first time in almost two years. Despite this, the US Federal
Reserve and other policymakers insist this spike will be temporary,
citing the effect of pent-up demand being released as economies
reopen and the fact most of the price pressure is in fast-recovering
areas hit hardest by Covid, such as air travel.
While higher and more volatile prices in the long term is a concern,
the more immediate worry is what central banks, despite efforts to
calm markets, might be forced to do if inflation continues to move
upwards. Interest rate rises, for example, have been the classic
way of curbing inflation but most countries have been able to keep
rates low to aid recovery from the pandemic and for much of the
last decade. Until recently the perception was that rate rises were
unlikely until 2024 at the earliest and anything before that, even if
still well into the future, would have an impact on sentiment.
for the future, with Fed chair Jerome Powell saying the economy is
not yet at the point where slowing asset purchases is appropriate.
It is increasingly clear policymakers are walking a tightrope,
working out the point at which inflation changes from a side
effect of growth to a challenge to it.
While the factors cited by central banks (liquidity, base effects
of higher energy prices and pent-up consumer demand) have
created the current spike in inflation, we do not see conditions
forming, for now, that pave the way towards persistent higher
prices over the longer term. Wage inflation has traditionally been
key to higher overall levels, but the forces of globalisation and
technology have kept this down in recent years and we believe
any meaningful pick-up is unlikely over the medium to long term.
Another part of the picture is central banks’ asset purchasing, known
as quantitative easing (QE), where they support the economy by
buying debt and flooding markets with liquidity. Stronger-thanexpected growth in the US and the UK has increased concerns
about when this support may be withdrawn, or tapered, which
could also spook investors and cause stock markets to fall.
The Liontrust Multi-Asset investment team added to our exposure to
index-linked bonds last year, for which the income paid rises in line
with inflation. While not predicting persistently higher prices, we felt
that, given the fact central banks are prepared to accept some inflation
as part of the recovery from Covid-19, higher index-linked exposure is
a sensible holding. We were also able to access it at more attractive
levels than today, where elevated inflation is reflected in prices; as
ever, we want to prepare for eventualities rather than react to them.
With the caveat that things are changing daily, what can we say
about the current state of play? At its June meeting, the US Federal
Reserve announced higher expectations for inflation for 2021 and
two potential rate rises in 2023. Even with the raised forecast for
this year, however, the Fed sees inflation moving down to its 2%
goal over the long run and continues to claim it has the tools to stop
things running too hot. For now, ending QE remains a discussion
We would also press the case for real assets, defined as tangible
assets such as buildings, toll roads, solar or wind farms or
commodities such as energy, livestock or grains, which derive
value from their availability and usability by consumers and
businesses. These have proved an effective hedge against rising
prices over a market cycle, with much of the revenue generated
structured as long-term inflation-linked contracts.
Why stock markets worry about high inflation
• Higher inflation means rising input costs (the cost of creating
a product or a service), which companies may not be able to
offset through passing on higher prices to customers.
• Higher inflation could pressure the US Federal Reserve and
other central banks to scale back loose monetary and fiscal
policies sooner than expected, which have been a major
contributor to ongoing all-time highs in stock markets.
• Higher inflation pushes bond yields up, which means higher
borrowing costs. This is a clear issue given high levels of
government and corporate debt, which was
increased to get through the pandemic.
• Inflation can be particularly damaging for
growth stocks in sectors like technology
as they rely more on the value of future
earnings, which is reduced if interest rates
are raised to contain the rate of inflation. This
would be more detrimental to markets such as
the US, where technology has been key to
overall returns over recent years.
5