Inflation

October 7, 2021

After a long period in which there was little to worry about, this has reappeared on the agenda. As it is a very significant factor in considering investment policy, it might be helpful to clients if we set out our current view.

Many of us, both in Thomson Tyndall and amongst our clients, remember the period of high inflation well and increasingly the younger generations without that experience are being educated about it. When inflation gets out of control, as it did for a period of years, it is frightening as those charged with financial policy seem unable to beat it, although happily they eventually did at the cost of a severe depression. The possibility of it happening again cannot be ignored.

How likely is it to be bad?

The debate is raging, as all will have observed. The fundamental problem is the lack of any meaningful figures because discussion tends to be based on comparisons with 12 months ago, in a chaotic period by all measures.

The authorities, and many commentators, view the recent rise as temporary and likely to be followed next year by a return to “normality”, circa 2% pa. A significant body of opinion thinks differently: that this is the beginning of a period of higher inflation than we have seen for a decade. Almost nobody thinks that a rerun of the eighties and nineties is likely. Equally, almost nobody expects a return to the price stability that we enjoyed pre-pandemic.

Policymakers now have more resources at their disposal to take heat out of the economy, such as reducing QE (tapering) as well as tax changes and interest rate rises. However, even the first can excite markets as they did with the “taper tantrum” recently. Interest rises perhaps need only to be modest from current levels and keeping them below the inflation rate would help to erode the vast national debt.

We mislaid our crystal ball some time ago and so have no greater insight than anyone else. However, that does not mean that we can avoid taking a view because we have to formulate investment recommendations for clients every day. Our current view can be summarised as:

  • Plan for inflation rising in the short term to perhaps 5% during the winter while the post-pandemic problems with supply chain glitches, staff shortages, wrong kind of staff in the wrong places etc etc are addressed.
  • Expect that it will plateau through much of 2022 before beginning to moderate as anti-inflation measures belatedly put in place begin to bite.
  • Do not expect runaway inflationary problems but stay alert for any signs of it worsening.

What does that mean in practical terms?

All generalisations are dangerous, and individual circumstances will often over-ride generalities, but we suggest:

  • Avoiding holding cash except for liquidity, but perhaps hold a bit more than usual because markets are likely to be volatile and forced selling for unexpected needs could be expensive.
  • Avoiding fixed-interest investments such as gilts (including index-linked, perhaps surprisingly) and corporate bonds. Not only are they paying very little but the risk of capital losses is significant if interest rates rise.
  • Holding “bond proxies”, funds such as renewable energy generators, battery storage, secured lending etc which are not directly in the equity markets, although if structured as investment trusts they will be quoted there, particularly where their income has some form of link with inflation or direct reference to inflation indices.
  • Holding “niche” property funds, again focussing on those with inflation protection such as the sheltered housing market.
  • Avoiding mainstream commercial property funds as the outlook for office occupancy is clouded.
  • Holding equities as they represent real businesses which can in many cases adjust their business plans to offset inflationary pressures, but expect volatility and extend the timeframe for which it may be necessary to hold through panic market drawdowns.
  • Investing internationally, as inflationary experiences and the policies adopted by different financial authorities will vary significantly in different economies.
  • Crossing your fingers!

Talk to your adviser

How important inflationary considerations are will vary considerably from client to client. For example, someone whose income needs in retirement are covered by index-linked government pensions can afford to relax more than someone dependent on investment income to live.

At Thomson Tyndall (and all its predecessors) we have always given “bespoke” advice to each and every client and we will continue to do so. The extent to which inflationary considerations should govern investment decisions will depend not only on direct financial factors but the individual outlook: what may be the best answer for one client will not suit another.

If there are any matters you would like to discuss in relation to this commentary, or any aspect of your financial planning, then please do not hesitate to get in touch

 

Investing involves the risk that your capital goes down as well as up; you may get back less than you invested. The commentary above is not intended as a recommendation for you to buy or sell any investments mentioned, although of course Thomson Tyndall transacts in such investments on behalf of its clients.