MoneyWeek has warned for some time that we will see inflation as the economy reopens after the pandemic. Covid-19 and our response to it created a unique set of circumstances: the economic shutdown caused the supply of goods to collapse, while consumers and employees were in many cases stuck at home for long periods. But revenues have been maintained thanks to public spending on furlough schemes in the UK and similar schemes in the rest of the developed world. So we had the most unusual recession of all time: demand collapsed, but household balance sheets remained intact. As a result, when the economy reopened, demand surged and supply – hampered by the long shutdown – simply couldn’t keep up. The result was that prices rose rapidly.
But there is more than that. Until very recently, central banks treated this inflation as “transient” – something that will disappear as soon as supply chains are unraveled and the economy returns to “normal”. However, while the pandemic has accelerated the return to a more inflationary world, there are plenty of arguments to say that we were already heading in that direction.
The main factors behind the long-term disinflation that the world has enjoyed since at least the 1990s no longer have the power they once had. The opening of Eastern Europe and China, which created more trade routes while providing employers with a large pool of cheap labor that suppressed wages worldwide, is now a depleted force. Likewise, it is no longer clear that the internet and technology in general represent competitive pressure driving down prices – instead, internet giants are increasingly accused of monopoly power while the shift to “green” energy technology will prove highly inflationary in the medium term. .
Meanwhile, in the wake of the pandemic, governments are so heavily indebted that inflation (which lowers the “real” cost of debt by allowing a country to pay off its debt with an inflated currency) may well be the the least politically painful solution to make public the finances put back in order.
What this means for your money
What does all this mean for your investments? A backdrop of persistent inflation – whether moderate price increases of 3-4% or 1970s-style double-digit surges – is something most investors in developed countries will not experience. seen in their lifetime. But we are already seeing the side effects in the markets. As investors began to worry that central banks would respond to rising prices by raising interest rates, speculative stocks plunged. This is the main reason why the technology-focused Nasdaq index in the US has underperformed the UK’s FTSE 100 so badly year-to-date. The Nasdaq is home to the exciting growth and digital economy stocks that have done so well over the past five years or more. The FTSE 100, on the other hand, contains “value” (cheap) stocks which operate in the boring old “real” industries – oil, mining and consumer goods, not to mention high street banks (which tend to benefit from higher) .
We suspect that this “great spin” (as it is sometimes described) from growth to value will continue as central banks try to distinguish between managing inflation expectations and ensuring that interest rates do not rise enough to bankrupt governments (and mortgage holders). All this before even considering the impact of the invasion of Ukraine. So if you’re looking for funds to put in your Isa that could help protect your portfolio from inflation, what should you consider?
History suggests that once inflation gets above about 4%, life gets tough for most stocks. But commodities, and commodity producers, can provide some protection. One option is to invest in BlackRock World Mining (LSE: BRWM) investment trust, which holds a portfolio of leading mining stocks from around the world. For wider exposure, opt for a simple FTSE 100 tracker, like the iShares Core FTSE 100 UCITS ETF (LSE: ISF). The UK index is cheap compared to other developed markets and contains a heavy weighting towards oil and mining, not to mention the major consumer goods groups which should have pricing power in an inflationary world.
One thing we believe all investors should have some exposure to in their portfolio is gold. It is a useful hedge against inflation and general market turbulence. You can invest through a fund such as the Royal Mint physical gold (LSE: RMAP). Finally, if you are tempted to bet on value stocks, a popular option is the Temple Bar Investment Trust (LSE: TMPL)which counts oil major BP, energy supplier Centrica and Royal Mail among its top holdings.