Inflation is riding high on ASX investors’ radars.
And for good reason.
Inflation is to economies and share markets as salt is to a meal.
Most economists argue you want a little inflation (say 2–3%) to keep consumers and businesses spending, deflate mountainous government debt piles, and generally keep things ticking along. But if you add too much you spoil the broth. (Pardon the mixed analogies.)
The latest figures you need to know
Now, the latest inflation figures out of Australia remain subdued…for now. The headline consumer price index (CPI) rose 0.6% in the first quarter of the year compared to the previous quarter.
But things are heating up faster in the United States. And as the US leads the developed world in so many ways, investors would be wise to tune in to the American’s much larger jump in inflation figures.
Headline CPI in the US rose 0.8% in April (month-on-month), bringing CPI for the year to 4.2%. That’s significantly higher than consensus forecasts.
Inflation fears caused US markets to selloff for much of this week. High growth tech shares more dependent on easy money were particularly hard hit. Though yesterday (overnight Aussie time) US markets rebounded strongly.
Those same inflation fears saw the S&P/ASX 200 Index (ASX: XJO) fall for 3 consecutive days this week. Today the ASX 200 is following the ‘buy the dip’ trend in US markets. It’s up 0.9% in intraday trading, though still down 1.8% from Monday’s all-time closing high.
With some major share market swings this week, the question making the rounds among analysts is whether investors’ inflation fears are well grounded or unfounded.
Is inflation really bad news for your ASX shares?
The answer to that question depends on who you ask.
In the ‘no’ camp we have strategists at Credit Suisse Group AG, led by Jonathan Golub.
As Bloomberg reports, the strategists say that over the past year “rising inflation expectations – measured by changes in the five-year breakeven rate – have coincided with positive returns for stock indexes”.
“In contrast to the market’s recent pullback, stock prices tend to increase in periods of higher inflation,” they wrote. They noted that, “In the S&P 500 Index, every sector has, on average, gained on days when concerns over inflation were also on the uptick.”
Energy and financial shares have gained the most on upticks in inflation concerns, with staples and utility shares gaining the least.
In the ‘yes’ inflation is bad for share markets camp we have Leuthold Group.
Leuthold looked at the longer-term relationship between the US CPI figures and the price-earnings (P/E) ratio for the MSCI US Index.
According to Leuthold’s Chun Wang (quoted by Bloomberg):
Equity investors might feel it’s too hot, as higher inflation has historically been associated with lower equity valuations. Admittedly, this relationship has weakened over the past two years but, given the heady valuation level today, it wouldn’t take a big increase in inflation to trigger a derating move.
Taking the middle ground – and going along with our ‘inflation is like salt’ analogy up top – is Keith Lerner, chief market strategist at Truist Advisory Services:
Some inflation is fine for the overall equity market. If you have some inflation and it’s not moving at too rapid of a pace, companies can pass along costs, there’s not sticker shock for the consumer. Yes, some inflation is healthy, but if it gets too hot too fast, there are concerns.
Chief among those concerns in our debt-laden societies are unexpectedly rapid and sharp increases in interest rates and bond yields.
Inflation surprises to the upside…now what?
After chasing higher inflation for years, the US Fed may be getting more than it asked for.
Addressing the US inflation spike, Justin Tyler, founder of Daintree Capital said (quoted by the Australian Financial Review), “I think it does change things for most people. No one thought that we would see anything quite this large. This sort of data should, if anything, bring about some humility when we talk about markets.”
Romano Sala Tena, portfolio manager at Katana Asset Management said:
That April CPI number doesn’t say inflation is coming – it says inflation has arrived. We are starting to rebase our views on that and how quickly central banks are going to reposition and bring forward monetary policy…
The investors who would suffer if rising interest rate expectations prompted another prolonged sharp rise in bond yields are those in the tech space or invested in other long-duration assets.
The discount rate increases and future earnings look less attractive today in dollar terms. So, you know, earning a dollar 10 years out isn’t worth 90¢. It’s more like 50¢.
So what shares will do well in a higher inflation environment?
According to Sala Tena the banks and producers have gained from rising inflation. “Basically, everything that’s running on the economic cycle should benefit because you’re getting some price appreciation. And the value stocks.”
Hugh Giddy, large cap portfolio manager at Investors Mutual, believes the inflation figures we’re being quoted are well below reality. And they could get much worse if central banks and governments keep their easy money policies in high gear:
I think inflation will rise very strongly if we keep on with interest rate policies and government over-stimulus and excessively low interest rates. Inflation, as properly measured, would be already off the charts because people’s major purchase is a house and house prices are going up everywhere.
Getting on the right side of these trends
While the US looks to be leading the charge towards higher inflation, Australia and much of the rest of the world may not be far behind.
As Saxo Market’s Australian Market Strategist, Eleanor Creagh writes:
Outside of the US a global manufacturing output prices are sitting at the highest level since 2009 as the sector remains hampered by supply chain delays and input shortages. Although the input cost hikes may be transitory to some degree, companies aren’t waiting, and inflation expectations are growing. Consumers’ expectations for price inflation are the highest in 7 years.
So what’s an ASX investor to do?
According to Creagh:
Despite the Fed playing down inflation and continuing to point to transitory inflationary pressures (a trend that is clearly not transpiring in the real world), for markets, fresh drivers of this emergent trend are likely to be found in coming months as economic data collides with extremely favourable base effects, supply shortages and rebounding demand…
As the year progresses it will be increasingly important to be on the right side of these trends, reallocating from bonds to commodities and equities – positioning toward higher inflation, commodities, cyclicals, and higher rates.
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Motley Fool contributor Bernd Struben has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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