There has recently been a change in tune from the authorities when it comes to inflation. For months the narrative was that this would be “transitory”. Now, higher inflation, it seems, is here to stay.
Economies contracted globally in early 2020 at the start of the pandemic. Demand has since rebounded and is now facing reduced supply. Robust demand chasing too few goods is likely to provide upward pressure on prices.
There are also longer-term factors driving inflation. The pandemic highlighted the global economy’s dependence on fragile, just-in-time supply chains. A more conservative approach is anticipated going forward, with supply chains to become shorter and more resilient. The resulting increase in operating costs will likely be passed on to the consumer. Meanwhile, the energy transition has resulted in reduced investment and less favourable financing conditions for fossil fuels, which remain a vital input into transport, manufacturing, and the power grid. Reduced supply and rising demand will mean higher prices.
The results
This has resulted in inflationary conditions that central banks can no longer ignore. Support is being withdrawn, with the proverbial punchbowl being taken away. Quantitative easing programmes (the purchase of government debt by central banks to lower borrowing costs) are being dialled back and interest rates are set to rise.
We think this will likely result in a change in financial market leadership. “Growth” stocks were beneficiaries of the anaemic economic growth environment of the past decade. But growth is rebounding and a rotation into “value” sectors, such as commodity producers and financials, is underway. Such sectors have historically been more insulated from inflation and have fared better during periods of higher rates and higher growth.
Alongside equities, the tightening of conditions also has ramifications for bonds, the other component of the traditionally balanced portfolio. Rising interest rates and the slowing of central bank purchasing activity would see bond yields rise, and in turn the price of fixed-rate bonds fall.
Charities should be asking their investment managers how sustained inflation and rising interest rates are likely to affect their investment portfolios going forward.
Charles Auer is an investment associate at Ruffer
Ruffer LLP is a limited liability partnership, registered in England with registered number OC305288 authorised and regulated by the Financial Conduct Authority. The information contained in this article does not constitute investment advice or research and should not be used as the basis of any investment decision.
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