Inflationary Times

There have been many issues to tax investors’ minds over the last few months: events in North Africa and the attendant rise in the oil price, the Japanese earthquake and tsunami and their effect on the global supply chain and the Eurozone ‘crisis’ which rumbles on in the background, Portugal being the latest country (at least at the time I write) to seek a bailout.  However, perhaps the most immediate to investors, individuals and companies alike is inflation.

Many of the world’s leading central banks appear to be moving back towards a monetary tightening stance, raising rates to combat inflation. The European Central Bank has raised its key interest rate by a quarter per cent to 1.25 per cent, drawing a hefty amount of criticism for doing so. There is concern that the weaker peripheral countries in the Eurozone, such as Portugal and Ireland, will not be able to withstand higher interest rates. 

Here in the UK however, despite CPI inflation running at 4.4 per cent, expectations have shifted from a potential spring rate rise to a later move, as the government’s austerity programme is only now beginning to be felt.  The new tax year marked the next phase of the programme as ‘worse-off Wednesday’ ushered in a number of changes to tax allowances and benefits that will impact a large number of families in the so-called ‘squeezed middle’. The esteemed Financial Times commentator Martin Wolf put it succinctly when he dubbed the new era NASTY (‘nightmare of austere and stagflationary years’) and asked if the Monetary Policy Committee should respond to the inflationary overshoot by raising rates, despite economic fragility and fiscal austerity, or continue to assume that the overshoot is temporary and will soon end.

The case for waiting and seeing remains strong, as the economy has been stagnating over the last two quarters and broad money supply shrinking.  Against this though is the rise in global commodity prices, which shows no signs of abating. 

The stockmarket has been surprisingly strong in the face of the surge in commodity prices, but this is now beginning to feed through into analyst expectations for company profits and the rally has stalled a little.  Earnings were remarkably resilient coming out of the financial crisis, but some sectors are beginning to be impacted by rising input costs.  Consumer discretionary and staples companies are seeing downwards revisions, on fears that shoppers will be hit by higher petrol prices on top of the aforementioned tax and benefit changes. Industrials are also likely to be impacted as raw material costs rise, while utility companies are expected to see earnings shrink as governments seek to limit the impact of price rises on the public.  

There may be surprises though as materials groups benefit from rising prices for metals, oils and grains.  Energy company earnings should be similarly strong on recent oil price strength.  Financial stocks could gain as trading profits are driven by investors reacting to events in Japan and the Middle East and those with more retail banking exposure might still benefit from earlier improvements in the financial health of consumers and companies. 

Of course, only time will tell and as ever we recommend investors to be selective, but at all times to remain well-diversified.

This does not constitute a recommendation to buy or sell investments and the value of any shares may fall as well as rise. Investments carry risk and investors may not receive back the amount invested.  The views expressed are those of the author and not necessarily of SWIM.

Cunningham Coates Stockbrokers is a trading name of Smith & Williamson Investment Management Limited.  Authorised and regulated by the Financial Services Authority. Registered number 131816.