Inflation: have we entered the 'Roaring 2020s?'
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WORDS ON WEALTH
In recent decades, inflation hasn’t been a big issue. In developed countries it has been remarkably low, even after the global financial crisis in 2008. It has even dipped below zero, resulting in deflation in some countries. And while not as low here in South Africa, it has been pretty well kept under control by the SA Reserve Bank, only occasionally creeping above the 3-6% target range.
I wrote about inflation back in May, when the first signs of inflationary pressures appeared in the US. The commentators I quoted were generally of the opinion that the rise in inflation was temporary as economies rebounded from the pandemic – what they referred to as a “base effect”.
A quick explanation: base effect refers to the exaggerated growth, when expressed as a percentage, that occurs after an economy has taken a dive and then returns to normal. As a simple example, take a company share at R100. In a market crash it loses 50% of its value, its price dropping to R50. When the market returns to normal, the share, if it rebounds to its pre-crash price of R100, will increase in value by 100%.
While probably the majority of mainstream analysts still maintain that the uptick in inflation is transitory, others are beginning to question their assumptions, and some have even become quite alarmist.
If central banks are behind the curve in reacting to a rise in inflation, it is more likely to get out of hand, and a sudden sharp rise in interest rates to counteract it can have hugely detrimental effects on an economy. But while the South African Reserve Bank last week took steps to counter inflation by raising interest rates slightly, the US Federal Reserve is yet to do so, despite US consumer inflation reaching a 31-year high in October of 6.1%. The US Fed has, however, started tapering its inflationary bond buy-back programme.
Back in July, Berlinda Liu, director of global research and design at S&P Dow Jones Indices, questioned the “transitory” narrative. In a blog, “Will inflation actually be transitory?”, she said the base-effect explanation made sense if you were looking at year-on-year figures, but not if you were looking at inflation month by month.
“It remains to be seen whether the inflation of the past few months is only due to the reopening of the economy and pent-up demand. The US Fed’s US$7 trillion [bond] buying binge may yet finally overcome the disinflationary pressures of technological development, demographic changes, and globalisation over the past 30 years,” Liu wrote.
More recently, the Wall Street Journal’s James Mackintosh said the Fed was “running out of excuses”. “Inflation hasn’t turned out to be temporary and has accelerated, reaching the highest in a single month since January 1990. It is high even when measured against pre-pandemic prices, so this isn’t merely catch-up … it is no longer merely about a narrow set of Covid-disrupted supply chains.”
Mackintosh said investors still buy the story that inflation is transitory – though not as temporary as hoped – but “the risk is rising that the Fed has to act much more aggressively”.
A recent Washington Post article pointed out that inflation is not just a number – it has psychological consequences on consumers and workers. The article quoted Atlanta Federal Reserve President Raphael Bostic, whose concern was that “the longer inflation remains high, the more likely it is that businesses and workers begin to believe that inflation will not come back down. Then they begin to alter their habits.”
Bostic was quoted as saying that if workers demand pay increases because the purchasing power of their money is decreasing, this leads to companies hiking prices, at which point workers will demand another pay rise. Economists call this a “wage-price spiral”, which often leads to sustained high inflation, and some believe it has already begun.
Schroders’ chief economist Keith Wade, in a deliberately provocative article, “The view from 2030: How transitory inflation became permanent in the ‘Roaring 2020s’”, reviews this decade using “hindsight”, as a future historian might.
“Looking back, it was clear that the seeds of higher inflation were sown before the Covid pandemic ended. What started as a ‘transitory’ rise in prices in 2021, turned into something far more persistent. With the benefit of a 2030 vantage point, it was clear that easy monetary and fiscal policy and a desire to avoid the mistakes of the past fuelled what is now known as the roaring inflation of the 2020s,” Wade writes.
ADVICE FOR INVESTORS
What if Wade is right? What if we’re entering the “Roaring 2020s”? How can investors prepare themselves?
Ricardo Teixeira, a Certified Financial Planner and chief operating officer of wealth advisory firm BDO, says inflation must always be top of mind for investors, whether it is at four percent or eight percent.
“The approach, which we impress upon all our clients, is to have an investment strategy that deals with inflation. What we see, and this is common behaviour, is that people are very fearful of losing money, and so they avoid taking risks. But without taking risks, we don't keep pace with inflation. And the biggest single strategy to keep pace with inflation is to make sure you have an allocation to growth assets – equities, bonds, property – and you are not just in cash.”
Teixeira says that your income, unless you are in an industry that is hard hit, will probably keep pace with inflation. “The problem is that many of the items we spend our money on have inflation rates that are different to the quoted figure: for example, petrol prices and utilities (electricity) go up faster than the quoted inflation rate. So you also need to ensure that you are spending wisely, but also ensure that your savings are growing at a rate above inflation,” he says.
Retirees relying on their investments for an income also need to have growth assets in their portfolios.
Teixeira says clients are not asking so much about what to do with their current portfolios, but about whether future investment returns will outperform inflation if we go into a sustained high-inflation environment.
“That's difficult to answer, because we are coming out of a pandemic and out of a really tough low-growth environment, and so the sudden surge in inflation is because we have seen a bit of growth. The one view is that it will be transitory and will stabilise in time, which makes economic sense, but there is the risk that the world could have changed fundamentally. If economic fundamentals have changed as a result of the pandemic, there is the question of whether growth assets like equities will be able to keep pace with inflation, and that is a risk. But what I can go back to is to make sure you are allocated to the best-performing asset class.”