As countries across the world roll out Covid-19 vaccines at varying rates, markets are grappling with the investment implications arising from the gradual re-opening of the global economy, and a recovery from the drastic slump recorded in 2020. This will impact different sectors in different ways, but one of the biggest over-arching questions right now is this: will inflation return as an issue for investors to worry about, potentially in a way not seen in a generation?
These concerns are understandable. It’s fair to say that we are certain about the prospect of recovery this year, but we lack all certainty about its magnitude. So far it looks as though activity in the first part of the year will continue to be subdued as governments remain cautious about re-opening, but the second half of the year could see a very significant recovery indeed. On top of the natural economic recovery we would expect after such a long period of suppressed demand, we then have loose monetary policy and increased government spending to contend with. Under the Joe Biden presidency, public spending in the US may go well beyond explicitly pandemic related stimulus, towards funding “green” infrastructure plans.
So there is a lot of fuel potentially being added to what should hopefully already be an economy that’s ready to motor ahead. Another point to note is that, for this year at least, the key investment risk associated with rising inflation is that interest rate expectations may start to rise too. This could imply a downside risk to various asset classes, notably equities, particularly those whose valuations are stretched relative to history, such as in the US.
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Deflationary forces remain strong
However, despite the extraordinary levels of government intervention in the economy, it’s important to recognise that the same deflationary undercurrents that existed prior to Covid-19 are still with us. Disruption of existing industries, driven by relentless technological advances, has been a long-running trend, and it is one which may even have been accelerated by the pandemic. High and rising debt levels also tend to be associated with periods of lower growth over the longer run. Meanwhile, weakness in the labour market caused by the pandemic is another force that will likely act against inflationary pressures.
In all, we suspect that these factors will combine to prevent a meaningful, sustained pick-up in inflation.This suggests that the low-yield environment will continue and thus remain challenging for investors seeking yield, which in turn makes it supportive for equities in general, given that they still offer very attractive earnings yields compared to the income that can be gleaned from bond yields.
Of course, this does not mean that investors can relax and ignore the “big picture”. One factor to be aware of, given the backdrop of high government spending and debt levels, is that governments will at some point in the future be looking to raise the money to pay down the debt. A prudent investor should consider this when looking both at market valuations (higher corporation taxes may be a risk) and their own personal finances (capital gains taxes and the like may well be options that cash-strapped governments consider in their future budget plans).
Investing in resilience and high quality
All of this represents another good reason to ensure that your investments are diversified globally, and invested in resilient companies with strong pricing power and sound balance sheets. The Martin Currie Global Portfolio Trust invests in a concentrated portfolio (around 25 to 40 holdings) of market-leading companies with sustainable business models, carefully selected from stock markets around the world. We make sure that we only invest in companies that are well placed to take advantage of the long-term opportunities created by technological disruption, rather than fall victim to it. These areas include everything from the structural shift away from the use of fossil fuels, to the evolution and transformation of global payment systems.
Our focus on hunting for quality within sectors benefiting from long-term growth themes means we should be able to find companies that are generating high returns, which can be sustained over the long run. Such companies are well placed to ride out whatever the macroeconomic backdrop throws at them. Dominant companies with strong pricing power can cope with rising inflation better than price-takers. On the other hand, if the economic recovery disappoints or stimulus fails to materialise, their solid balance sheets and market leadership put them in the best position to compete and grow in a weak growth environment.
We also take an active approach to ESG (environmental, social and governance) issues. After all, if a company is to remain a market leader in its sector over the long-term, its management team must take into account the physical and political environment in which it operates, and how its actions have an impact on the wider world beyond its owners. It’s not about “looking good” or paying lip service to headlines. Well-run, productive companies should have a positive impact on the world around them – it’s simple business sense.
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