The year so far has not been kind to most investors. The S&P 500 is down 5.2% in the year to date, the Nasdaq is down 9.4% and the Dax is down 2.3%. There’s a hint of a new interest in value in the relative resilience of the FTSE 100 (up 1.2%). But still, I doubt many people are looking at their pension savings and dragging their retirement date earlier (as it seems many did last year).
This is maddening for fund managers – or so they keep telling me. As they see it, the fundamental performance of the companies in which they invest remains unchanged. Earnings are coming in just as expected. In the US, the forward revenues of the S&P 500 and of the S&P 400 (the mid-caps) “both continued rising in record high territory” through 20 January, says Ed Yardeni of Yardeni Research. Some say this is just about inflation – companies are raising prices to cover rising costs, so revenues obviously rise. That’s true – but those rising costs aren’t hitting margins. Far from it: S&P 500 forward profit margins are at a record high of 13.3%. Nothing to worry about there.
But here’s the question: assuming inflation is not transitory (we are pretty sure it is not), can the world’s companies keep passing these increases on to the consumer? Fund managers I have spoken to in the last few weeks all say yes – that their companies have the pricing power to do so (Nick Train would say this about Diageo and Fever-Tree I think). But is this really possible? We would expect to see workers organise and wages to start rising fast in the not too distant future, but for now, with the British Retail Consortium reporting that UK shop prices rose at their fastest rate in nine years in January, and wages currently rising more slowly than inflation, it is likely that shoppers will soon have to cut back.
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Taking the inflation hit
Someone has to take that demand hit. Right now the investment industry is convinced that market volatility is all about the possibility of inflation leading to rising interest rates. But there is more to it than that: if inflation stays high it could rapidly hurt fundamentals too. Something we hope they are keeping a close eye on.
There are tricky times ahead for markets. But we take long-term heart from the fact that there are now 2,000 Isa millionaires in the UK – and even one investor with Isa savings of more than £6m. I’d love to see that portfolio.
But even without doing so I can guess at a few things about it. Odds are its owner did not get caught up in meme stocks. No GameStop there. I would also guess that its owner has a constant eye for price and simplicity – how much of the returns they make go to them, and how much to fund managers (if they use managers at all).
This dynamic has improved hugely over the last decade. Fees have fallen sharply, but it is still worth remembering that a good part of the industry, whatever feel-good muck it feeds us, is not on our side. Proof? In this week's magazine we look at the case of Chrysalis, an investment trust that – thanks to a shockingly badly-constructed fee arrangement – is paying out £117m to its managers (not far off 10% of its current market cap). The payout reflects good performance in the past. The trust is down over 18% in the year to date. None of it will be returned to reflect this. Definitely not on your side.
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Things won't just return to normal – that's not how inflation worksEditor's letter You might think that, if inflation is indeed “transitory”, we just need to wait and everything will return to “normal”. But this is a grave misunderstanding of how inflation works, says John Stepek.
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