There are two main dynamics at play at the moment that we at Greenfields are monitoring closely. On one hand, there is the potential that there will be a large positive impact on economic growth, spurred by the combined effect of pent-up demand and the fiscal stimulus (increased government spending). On the other hand, there are signs that inflation is creeping back in and may get higher. Even though this higher inflation may only be modest and temporary, it will be interesting to see how policy makers deal with it as historically this has led to interest rates being hiked (over time) to curb it. This view is the main reason why markets have stuttered of late.
How can assets go down if economic growth is going to pick up?
Inflation (the general rising of prices) can be positive for asset holders if product values rise faster than the general level of inflation. This is the key reason for us either increasing or adding a global infrastructure fund (investing in real assets) into many of our client’s portfolios in recent months, with many of their income streams being linked to inflation. Inflation, however, can be bad for anyone with a fixed income, and bonds are therefore an obvious casualty, with fixed interest payments that become less valuable as inflation rises.
When talking about a potential rise in inflation, equities might sound like a more appealing option because, in theory, if prices rise then so too should revenues and share prices. However, this could be offset by a shrink in profit margins as input costs go up for businesses. As a result, those future cash flows will then be discounted at a higher rate when inflation increases, to compensate for them being worth less.
But…
Many economists are forecasting a surge of growth for the rest of 2021 as we finally get free of the restrictions which have been in place. The positive road ahead has been displayed by economies like China and Australia – where their management of the pandemic has been good, and they are now beginning to reopen. China’s economy grew by 6.5% in the last quarter of 2020 and is set to record a massive growth in GDP this year according to Bloomberg forecasts. Fiscal stimulus is driving these recoveries and provided central banks continue to support economies as we return to normal, one could remain confident that the recent fall will not be a sustained one.
A key point to remember is that this is the biggest economic event for almost 300 years, and whilst inflation may rise due to structural factors, the fiscal stimulus that has been enacted is in response to a monumental economic crisis. The money being given to support economies is a lifeline rather than free cash. Given this, we are monitoring the situation, as a return to sustained higher inflation will be contrary to market conditions seen since the 1980’s.
At Greenfields, our experts are closely monitoring the market and inflation rates as we start to emerge on the other side of the pandemic, and we are here to discuss any issues or questions our clients have.
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For more information on the market and inflation news, you may be interested in reading Market Intelligence Analyst Sean Markowicz’s piece on inflation here.