Page 24 - DIY Investor Magazine | Issue 29

INFLATION AND FINANCIALS CONCERN OR OPPORTUNITY?
Many central banks in the developed Western world have an inflation target of around 2%, a figure deemed appropriate to provide the right combination of optimum employment, price stability and economic growth – writes Nick Brind, Fund Manager, Polar Capital Global Financials Trust plc
Nick Brind, Fund Manager
The one partial outlier from this is the US Federal Reserve (Fed), which recently changed its inflation target to an average of 2% over time – though, interestingly, without clarifying over what time.
By and large, they have all remained at this level since 2012, and the recovery following the global financial crisis. At the end of March this year, consumer price inflation (CPI) was 0.7% according to the Bank of England, 1.3% from the European Central Bank and 2.6% from the Fed.
‘FINANCIALS – MORE SPECIFICALLY THE BANKING SECTOR – STAND TO BE A PRIMARY BENEFICIARY OF AN UPWARD MOVE IN BOTH INFLATION AND INTEREST RATE EXPECTATIONS’
However, the equivalent figures at the end of April showed a marked increase, up to 1.5% in the UK, 1.6% across Europe and 4.2% in the US, its highest level since September 2008. These increases are based on the rapid rise in demand of pent-up consumer spending – through physical retailers as well as online – as economies open up thanks to the continued vaccine rollout, alongside the constraints put on the other side of the economic coin, the supply chain.
Underlying all of this is the position economies were in one year ago, the point on which all these numbers are based, which was when the World Health Organisation declared COVID-19 a global pandemic.
The reaction was immediate and drastic – the Dow Jones saw its single largest daily drop in history; the VIX, a volatility or ‘fear’ index, hit an all-time high; January to mid-March 2020 saw the S&P 500 down 27%, the DAX down 38% and the Nikkei down 29%.
The FTSE 100 fell by 25%, its largest quarterly fall in 30 years. Given the scale of these lows, sentiment has unsurprisingly been for a rise in inflation 12 months later so, while the outlook from here is heavily dependent on progress globally in containing COVID-19, should we be worried about inflation?
There are two camps answering this question. One is investors on the side of the Fed and its view that the current pressures are temporary, so of little concern.
The other is those on the side of the current trends/evidence in the real economy – including house price inflation, rising cost of consumer goods, supply bottlenecks, and some labour shortages and wage pressures – which may eventually embed themselves in longer-term inflationary pressures.
With portfolios heavily skewed towards bank stocks, it is not surprising we are in the latter camp, albeit not alone as the movements in bond yields would suggest.
WHAT DOES THIS MEAN FOR FINANCIALS?
In simple terms, lower inflation and lower interest rates encourage increased consumer spending and higher levels of borrowing as returns on savings are limited. As spending increases, so do growth company revenues; as increased revenues are reported, share prices rise and stock markets rise.
‘THEY OFFER INVESTORS HIGH AND RISING DIVIDEND YIELDS AND RECOVERING TOP-LINE GROWTH’
DIY Investor Magazine | Jun 2021 24