Inflation- the silent killer of your wealth.
KEY TAKE-AWAYS:
Between Feb and March 2021 the purchasing power of the USD eroded in half 15 years more quickly!
The herd of asset managers are making the inflation issue one of the central topics on market chatter.
In Japan they see inflation heating up in the US as a “fire on a distant shore”. They want it! They miss it.
Japanese, US and UK Central Banks(for example) seem to favour a 2% p.a “ideal” inflation rate.
The “comfort range” for our herd asset managers seems to straddle the 2% ideal. With 1% at the lower end and 4% at the upper end.
Lebanon- a purchasing power crisis close to home.
One subject dominating asset manager speak today is the subject of inflation. Our quest today is to aggregate the asset manager herd on the silent killer- what are the parameters of their worry?
To understand that discussion we take you to Utopia where there is zero inflation and where you can enjoy three bottles of Chateau La Mission Haut-Brion (2015) and awaken without a headache from what my earth-bound doctor calls “excess”.
In Utopia the lack of inflation also means the lack of deflation. All this means that the area under the mattress where my Gran kept her money is deemed to be a “safe haven” for holding-the-folding (the cash notes) as purchasing power is protected. Everything else falls into the risk definition of Justice Putnam’s “Prudent Man Rule”- do what you will, your capital is at risk. In Utopia, the Under-The-Mattress haven has a compelling attraction because of its lack of risk to purchasing power. This would appeal to some of Putnum’s (1768-1853) “men of prudence” and how they use their “ discretion and intelligence” to “ manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds”.
Here on planet earth, the mattress is less haven-friendly. Men of Prudence will be aware that inflation eats away at purchasing power in an unspectacular fashion like a bad diet eats away at our health. If we take the current USD inflation rate at 2.6% in March 2021- a jump from 1.7% in February (source: Trading Economics) and we apply the useful “Rule of 71.8”, we note that in Feb 2021 purchasing power eroded by half over a period of 42 years. In March that rate dwindled to 27 years, and at 4% purchasing power would erode in half over 17 years. In the Lebanon (inflation at 85.45% p.a) purchasing power erodes in half on the local currency over 8 months. In Venezuela (a staggering 6500%) we are down to an erosion rate in minutes.
Is inflation all bad? Apparently not. Firstly, in theory, when the economy is not running at full capacity more dollars translates to more production, that translates to more demand and that translates to more jobs. Secondly, inflation is way, way better than deflation. Deflation means the falling price of goods and services. In Japan they have been battling deflation for two decades and their Central Bank remains unhappy (prices falling another 0.4% in Feb 2021). Global Central Banks look at Japan and steer their ship as far away from those deflationary shores as possible. There is no practical, workable, experience to fall back on if deflation bites. Thirdly, for investors- and especially those prepared to ride the turbulence of markets- their risk asset performance needs to be somewhere around 5 to 6% p.a to improve purchasing power. This requires assumptions of the 2% “ideal” inflation rate and 2% charges (both belong to lick-finger-stick-in-air brand of certainty). A “real” return of 5%p.a. against 4% worth of obstacles provides an improvement in wealth and purchasing power.
THE HERD VIEW:
So what does the herd think of the purchasing power conundrum? Phil Smeaton (Sanlam/VAM): “Below 1% Core CPI inflation, equities struggles as that is the level at which the market becomes worried about deflation as there is simply not enough revenue growth to help everybody out and we share this view. That is to say less than one glass of wine in Mondial’s analogy”. Smeaton continues: “ With respect to the upside, we should expect a 3% point which would be completely normal given the base effect. However, it may be because of supply chain difficulties and the magnitude of the restart that a 4% number is possible, but it’s not the level rather how long it stays there that we are concerned about. So once it hits the 3 or 4% number it should then start to fall off, but if it persists at that level then transitory becomes normal. Relating this to Mondial’s analogy, a Magnum of wine as a one-off blowout is within our comfort zone, but doing this on every night out would give us meaningful cause for concern.”
For Glyn Owen (Momentum), “taking the current situation rather than the longer term view”, Owen adopts a similar comfort zone to Smeaton “we would go for higher figures than ‘normal’, as the base effects are large and we are seeing strong commodity prices, some shortages of certain goods, and a sharp rise in producer input prices. So we would go for 1% and 4%” referencing the two book ends of the Momentum comfort zone.
Daniel Joliffe (Quilter Cheviot) is more the “journey that counts” in expecting a rise in inflation with the vaccine roll-out and as “as populations begin to revert to ‘normality’ and release the pent-up demand that has been building. However, rather than estimating the exact level that inflation will rise to, the more prudent question relates to how long the period of inflationary pressure will last for. The majority of market commentators have estimated that inflation will be relatively short-lived and Quilter Cheviot subscribe to this school of thought also. This view has been supported by the Federal Reserve maintaining that interest rates will not be raised before 2023, even if inflation exceeds their 2% target”.
In summary, the reason why the herd of asset managers are focussed on inflation relates to the obvious impact on the value of our money. An obvious effect on our financial planning needs and the effect on our purchasing power. The good news is that the herd seem to believe it is a worry that will be controlled. In short, the aggregate opinion is that we will witness some inflation but not to the level which will cause us a headache!