Page 25 - DIY Investor Magazine | Issue 29

However, if current sentiment is right and inflation goes up, physical asset prices (housing; commodities) will rise but purchasing power will decrease so some of the demand for such growth companies will fall.
Equally, the current high valuations attached to growth businesses are based on valuation parameters which rely on low interest rates (ie growth companies start looking very expensive if interest (discount) rates rise).
On the flip side, while not necessarily a direct correlation, there is the suggestion of a positive connection between
mild inflation and the return on value stocks – high inflation is arguably not beneficial for any sector since interest rates will need to rise materially at a time when the world remains highly indebted.
As the most sensitive sector to the reflationary trade, financials – more specifically the banking sector – stand to be a primary beneficiary of an upward move in both inflation and interest rate expectations.
The underlying rationale for this view is that as interest rates rise, bank margins start widening after many years of severe pressure and the loan market becomes more competitive against the bond market and specialist forms of finance.
‘MANY ARE NOW IN A POSITION TO RETURN SIGNIFICANT AMOUNTS OF SURPLUS CAPITAL TO SHAREHOLDERS’
Financials are the largest constituent of value indices and
so provide diversification from growth sectors that have benefited from ultra-low rates (although we would reiterate that this requires a bias to the bank sector within the financials exposure).
Despite the global economic recovery, financials continue to trade at attractive valuations in absolute and relative terms.
The sector has outperformed by 5% from last year’s lows, compared to an average outperformance of 23%, looking at the past nine crises going back to 1990.
This suggests there is plenty of room for further outperformance as confidence in the economic recovery builds.
Looking within the sector, banks have shown high levels of resilience in what was a severe downturn, supported by the strengthening in their own balance sheets in the preceding years – thanks to the regulation brought in after the 2007- 09 global financial crisis – along with government stimulus support.
By comparison, this time around banks actually built up levels of capital during this downturn and many are now in a position to return significant amounts of surplus capital to shareholders.
25 DIY Investor Magazine | Jun 2021