Deciding where to place financial bets on company sectors, mega trends, individual companies, and collective investments like investment trusts are effected by macro economic factors.  This post is intended to tackle the concept of inflation and how it’s going to affect where readers may want to invest.

Mervyn King Baron of Lothbury, former Governor and member of the Monetary Policy Committee, spoke at a speech in 2013 and said that he has worked during a really ‘nice’ period in financial history.  King coined the term NICE to mean a period of “non-inflationary consistently expansionary”, NICE.  Companies and the economy continued to grow without any of the negative side effects normally associated with economic growth.  Inflation is one of these negative side effects.  Products (food, petrol, housing, etc) and services (legal, accounting etc) remained affordable whilst more and more people where employed and experienced rising wages.  Not only where things affordable many things got less expensive, like, personal computers, and cars.

NICE was a consequence of globalisation (relocating certain industries and work to places in other countries particularly China) and technological advances (including supply side reforms such as automation) which kept a lid on inflation.  During the 1990s that worked very well, but what’s changed?  Debt.  An explosion of debt which started with the low interested rate policies of Alan Greenspan former Federal Reserve chairman (various factors went into the mix with those decisions including the Sept 11th terrorist attacks).

What’s happened now?

NICE turned into a period of low or no growth with disinflation (falling inflation) or outright deflation.  Times like these really bring into focus the importance of placing the right financial bets and investing wisely for the future.  Debt has been discussed in more detail on other pages in the investing section here on Let’s Compare Bets.  In short, the financial authorities want to avoid a period like the 1930s when there was a depression with falling prices and low unemployment.  A period where Al Capone held the keys to the whiskey cabinet and people where desperate to make ends meet.  Now, due to the amount of debt in the system financial authorities need inflation to keep the system working.  Inflation in wages, economic gross domestic product etc  helps to reduce the amount of debt as as wealth (or money creation) out paces debt.  Deflation on the other hand increases debt, as there is less money to pay interest and make capital repayments, which causes less disposable income for buying goods and services, or, less money for companies to invest for the future. An increasing debt pile, no employment, and a time like the 1930s.  For normal people this would mean a time where there is no whiskey, no job, and and lots of frustrated people.

Right now political changes are bringing a catalyst for change.  President elect Trump in the USA brings inflation friendly policies and rhetoric to the table.  He has openly criticised America’s central bank for policies which are now causing serious harm to the economy.  Especially the very low interest rates and the possibility of negative interest rates, which have various negative sides effects including making banks very unstable and causing pensions to be under funded.

President Trump plans to reverse some of the drivers of low inflation.  Reducing the free movement of people, like illegal immigrants crossing the Mexican border (which stops wages being depressed).  Reducing the effects of globalisation by using trade tariffs and spending big on infrastructure.  Low corporate tax rates have been proposed which should encourage USA Inc. to bring their case hoards back to the USA.  Also many companies will be encouraged to bring manufacturing back from overseas.  President Trump want’s Apple to manufacture the iPhone in the USA and to bring their massive cash pile back home.  With low tax rates and a population getting paid more money Apple may be willing invest more in the USA to secure their future growth, for instance they are rumoured to be entering the automatic car market.  Trumpflation will also include big infrastructure spending paid for by creating money through the central bank (money printing).

Things are changing in Europe.  Trump seems very friendly with Nigel Farage who has been one of the main architects leading the United Kingdom’s exit from the European Union.  Apparently Trump doesn’t drink or smoke so it can’t be for the love of beer and cigars that Trump wants to cosy up to Nigel.  More likely is that President Trump supports Mr Farage’s view on Europe.  The UK was the first to leave Europe but the big question now is who will be next and when?

An exit from the European Union has been positive for the United Kingdom and has helped play a part in rebalancing the economy.  As the value of Pound Sterling dropped the price of imported goods have gone up helping promote supply side inflation.  Now we’ll have to wait and see if wages follow suit.  When wages start to follow suit interest rate rise won’t be far behind.  As the European Union continues to be remodeled there will be increased volatility in financial markets (prices plunging and rebounding), but, as an exit (sorry Brexit) has been good for the United Kingdom it would be good for other countries that leave in turn having a positive affect on the world economy.

Top 3 drivers of inflation

  • Trump is talking the talk on inflation.  Time will tell if he’s going to walk the walk, for instance, they are not going to find 1 trillion dollars down the back of the sopha to pay for infrastructure, and, how on earth is Trump going to persuade congress to agree to building a wall on the Mexican border.
  • Re design of common economic policies in Europe will also be positive for inflation.
  •  China have their own huge infrastructure spending plans – including building the silk road again with a maglev line.

Factors that will stop inflation getting out of control like it did in Weimer Germany in the 1920s will come from Geopolitics.  With cooperation between nation states, the continued use of globalisation and technology may allow the global economy to engineer a positive outcome for more people, without too much conflict.

Bottom line

How to invest for a future that exists with more inflation? Big trends linked to this include infrastructure spending and technology.  Other beneficiaries of rising inflation include banks because it will increase their margins.  A return of inflation will also allow supermarkets and food producers to increase their prices and increase their profit margins.  Profit margin increases can be hidden behind general inflationary price rises.   As wages rise and more people, especially in China, move into the middle classes they will want to travel more, have cars, and eat nice branded food.  Companies providing consumer staples may continue to benefit.  Further down the line the oil sector will also benefit from inflation.

What are the hidden beneficial affects of inflation 

Financial markets are driven by expectations.  Higher expected inflation causes changes in bond markets due to the change in interest rate expectations.  If central banks and politicians succeed in engineering higher inflation and higher interest rate expectations money should rotate out of bond markets and into equity markets.  Bond markets are massive so there is a lot of money to move across to equity markets.  Managed in the right way that should be good for share prices as money will flow across.

Rising inflation and interest rate expectations will also help banks to make money which will help them with their own problems of none performing loans.

What are the possible risks

Too much inflation causing multiple interest rate hikes may cause serious national government debts problems, it could increase the number of people and companies not paying back their debts which in turn could  make many large banks across the globe insolvent.  If the bond market crashes violently pension funds may be badly affected, as would companies, and Governments.  Effects on pension funds should be offset as they are all forced to find a home for their money in equity markets.  But, it would be a rollercoaster ride for share prices.

Financial picks 

Linked to infrastructure spending;

  • iShare Global Infrastructure Exchange Traded Fund which pays dividends
  • HICL infrastructure Company Limited is a long term investor in infrastructure and pays a healthy and reliable dividend
  • certain UK companies will benefit from the National Infrastructure Delivery Plan 2016 – 2021.  Including construction companies like Costain, Morgan Sindall and Carillion plc.
  • Black Rock Commodities Income investment trust produces a high dividend (so investors get paid whilst they wait for inflation to return to the oil markets), however, it’s worth noting that the trust expects to reduce the dividend in the next couple of quarters.
  • When wages start to rise people will start to spend more in supermarkets.  For anyone investing in the UK companies Sainsbury’s and Tesco would be a good place to start.  Sainsbury has just purchased Argos which will help them with selling online.
  • Dairy Crest has just undergone a big change to their direction.  Dairy Crest did own a large dairy business which gave it a very reliable but boring business.  The potential for growth was limited.  Muller has now purchased the diary business leaving Dairy Crest to focus on it’s consumer brands including Cathedral City and Davidstow cheese, Clover spread, Frylight oil (a health alternative to other cooking oils), and ingredients of baby formula like demineralised whey.  Inflation would help the company reverse some of the brutal discounts they have been having to do on Cathedral City.  This change in direction should cause the company to be rated again more inline with other firms in the sector like Unilever. Dairy Crest has a reasonable dividend which they should be able to increase in the future.

Don’t forget to check out the other posts in this series for ideas about where to place your financial bets.