Apart from the Russia-Ukraine conflict, inflation is the overriding concern among investors today
Chief Investment Office 25 Apr 2022
- We look to glean insights from the 1910s, the decade that most closely resembles the present
- Key macro shifts suggest we may be at the start of a new inflationary era
- Outperformers include upstream operators as well as downstream companies
- Downstream companies are able to pass on rising costs to end consumers
- Commodities, Energy Majors & S-REITs are effective inflation hedges
Lessons from history – the greatest teacher. Once called “taxation without legislation” by famed economist Milton Friedman, inflation has roared back at the turn of the decade of the 2020s, threatening to impose its illegitimate, invisible tariffs upon the man on the street purchasing essential goods and services. This surge in prices has come as the world is emerging from a pandemic, approaching levels not seen in 40 years. As the impact of higher prices has far-reaching consequences, it is instructive to take a brief look back on inflationary episodes over the last century to glean some insight as we approach the decade ahead of us – what appears as unusual inflation to us in the present has in fact occurred many times throughout history with observable reoccurring patterns.
The costs of having too much money. A crude but well-acknowledged definition of inflation is the phenomenon of “too much money chasing too few goods”. It is therefore no coincidence that periods which saw an increase in the broad money supply generally held the critical kindling for an inflationary ignition. Money supply, in turn, generally increases under two main conditions:
- Higher private sector lending: Banks make more private loans and consequently create new deposits as a balancing accounting entry.
- Larger public sector debt monetisation: Governments run large fiscal deficits while the central bank creates new reserves to finance the bonds issued in relation to those deficits.
Identifying historical inflation peaks. Looking across the 20th century, there are three notable eras where inflation has been exceptionally high (US CPI increments of >10% pa), starting with:
- The 1910s inflation through World War I (WWI)
- The 1940s inflation through World War II (WWII)
- The 1960s-70s “Great Inflation”
We will go through each period to identify distinct events that resulted in either (a) an increase in broad money supply, or (b) a shortage of production of goods and services – factors that are well-known harbingers of inflationary cycles.
Beneficiaries of high inflation. Listed below are some of the key beneficiaries of a rising inflation environment:
Commodities: We believe oil, base metals, and gold will outperform given the supply shortage and energy transition narratives behind them. These factors will underpin prices in commodities.
Energy Majors: Rising energy prices is one of the key factors contributing to the inflation surge that we see today. Not surprisingly, investors can hedge their portfolio against inflation by gaining exposure to energy majors – geared beneficiaries of high energy prices.
S-REITs: S-REITs have provided stable dividend yield between 5-6%, and since the last decade, they have delivered strong returns, coming from consistent dividend payouts as well as capital gains. S-REITs serve as a good inflation hedge given that rental and property values tend to rise in tandem with rising inflation.