You can’t really escape from inflation right now. As we discuss in this week's magazine, the evidence now suggests that “inflation is definitely not transitory”. Energy prices are surging even as the government waffles on about ways to make heating our homes even more expensive and less efficient (anyone keen to swap their gas boiler for a heat pump? Thought not).
The latest obscure commodity that we’ve realised the supply chain can’t do without is magnesium. Turns out that it’s not only a key ingredient in the aluminium alloys necessary to make almost any car, but that the supply is almost entirely monopolised by China. Finally, we’re seeing an ongoing global labour shortage, which, as far as I’m aware, is something that no one had expected to see as a post-pandemic outcome. Forecasts of economic “scarring” and jobs shortages were far more common.
So what are investors doing about it? The latest month survey of global fund managers from Bank of America is revealing. The world’s asset allocators are definitely now worried about inflation. The proportion who fear that inflation is “permanent” rather than “transitory” jumped from 28% in September to 38% this month. Meanwhile, they are more negative on bonds than they have been in the history of the survey (which goes back about 20 years – hardly a long view, but a decent period of time). This makes sense – investors know they don’t want to be in fixed-income assets if inflation, or worse still, interest rates are set to rise.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
However, investors aren’t yet bearish enough to flee to cash (for its optionality – it won’t necessarily protect you from inflation, but it gives you the chance to buy assets cheaper if they crash). Allocations to equities are still high by historic standards. Yet as Ruffer’s Duncan MacInnes recently pointed out on Citywire, equities don’t necessarily do a good job of protecting against inflation either. In fact, even equities with strong pricing power might struggle. Why? Because there are two key factors at play when it comes to equity valuations. One is earnings expectations. But the other is how much the market is willing to pay for those future earnings.
During a period of inflation, a firm may well use its pricing power to preserve, or even grow earnings in real terms (ie, after inflation). Yet the price investors are willing to pay for those earnings may fall. MacInnes cites US confectioner Hershey’s during the 1970s. The firm grew real earnings per share by two thirds between 1972 and 1975. Yet over the same period the share price fell by as much as two thirds, because the instability associated with inflation saw investors demand a much higher risk premium for buying stocks, which meant the multiple (ie, the price/earnings, or p/e, ratio) they were willing to pay fell sharply.
This makes sense. It also bodes ill for markets – US markets especially – because we’re starting with p/es at extreme highs compared with history. There are some places to hide – precious metals, commodity producers, certain financial stocks, certain emerging and frontier markets – but investors should be preparing for a very different backdrop to the one we’ve grown used to in the past decade. We’ll be discussing all of this at the MoneyWeek Wealth Summit on 25 November. Buy your ticket and learn more at moneyweekwealthsummit.co.uk.
John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
The 30 house price hotspots
While we have seen house prices sliding, these sought-after locations have seen prices jump by at least 5% over the previous 12 months
By John Fitzsimons Published
Working parents will be entitled to 15 hours free childcare for two-year-olds from next year
The government has extended free childcare hours to working parents of two-year olds but it won’t be automatic so make sure you don’t miss out
By Marc Shoffman Published
The rise and fall of Sam Bankman-Fried – the “boy wonder of crypto”
Why the fate of Sam Bankman-Fried reminds us to be wary of digital tokens and unregulated financial intermediaries.
By Jane Lewis Published
The jury's out on the AI summit at Bletchley Park
World governments gathered for an AI summit at Bletchley Park in November, but were they too focused on threats at the expense of economic benefits?
By Simon Wilson Published
As a market correction begins, money is on the move.
The force of a market correction is equal and opposite to the delusion that preceded it, so we can imagine that the correction will also be unparalleled.
By Bill Bonner Published
How small businesses can retain staff in a competitive job market
Small businesses are struggling to retain staff and compete against large companies with deep pockets.
By David Prosser Published
The French economy's Macron bubble is bursting
Cheap debt and a luxury boom have flattered the French economy. That streak of luck is running out.
By Matthew Lynn Published
K-pop hitman Bang Si-hyuk aims to repeat BTS phenomenon
Bang Si-hyuk created the world’s biggest boy band, BTS, making K-pop music a global sensation and himself very rich. Can he repeat the trick with a girl band?
By Jane Lewis Published
Nudge theory – how does it hold up, 15 years later?
Nudge theory, the revolutionary theory of how governments can get you to change your behavior for your own good, is now 15 years old. How does it stand up?
By Stuart Watkins Published
Betting on US politics – who'll be the next US President?
In the latest betting on US politics, with just over a year until the next US presidential election, punters pick Donald Trump as the favourite.
By Dr Matthew Partridge Published