Will inflation stop the party?

More than a year after the pandemic hit the world, shaking economies and markets, investors can now safely say their portfolios are in very different positions from last year, with stocks almost recording the same rate of growth in the first five months of 2021 as they did throughout 2020.

Now that stocks are comfortably seated on good gains, the focus is on inflation which, rightly so, has arisen following such a rally.

Before going deeper into this topic, one must consider the starting point that led to the current position, namely the unprecedented shutdown known due to the outbreak of COVID-19. Unlike previous recessions that were triggered by the natural forces of an economy – supply and demand, this recession was unprecedented in that it brought economic activity to a complete halt. This means that there is nothing natural about the cycle we are in.

The same goes for the measures implemented to counter its effects, with central banks and governments using all their strength with rapid stimulus measures like never before.

Now that immunization programs are underway and economies are reopening, the world is experiencing a surge in economic activity, driven by pent-up consumer demand and revenge spending to make up for lost time. Additionally, while last year saw consumers panic to buy and stock before closings, it is now businesses that are building up inventory and looking to expand their workforce, to meet customer demand.

This leads to shortages and bottlenecks, which in turn lead to higher prices, also known as an inflationary surge. While inflation is always present and is healthy when stable, a rapid rise in inflation results in uncomfortable suppliers experiencing rapid increases in their input costs, forcing them to pass on those costs more. high on the consumer in order to avoid squeezing profit margins. .

While last year we saw consumers panicking buying now, it’s the companies that are building up inventory and looking to expand their workforce.

There are many reasons why investors fear such a scenario. A rapid rise in prices dilutes the purchasing power of consumers and ultimately leads to a drop in demand because households will no longer be able to afford the same quantity of goods as before. This in turn translates into lower sales volumes on the corporate side and lower profit margins. Moreover, or rather, more importantly, such a dynamic prompts central banks to tighten their monetary policy and control inflation by raising interest rates, i.e. by increasing borrowing costs. for companies.

These fears showed signs of manifesting in the second week of May, when we saw global stocks fall by around 3.5% in four days as investors sold their positions and locked in their accumulated profits.

The question now is: where will these funds be directed? And it is here that the acronym “TINA” which will soon be one year old prevails. “TINA” means “there is no alternative”, a phrase used in conjunction with stocks, because in the midst of low interest rates, with bonds offering such low yields and cash not an attractive option , stocks were the only viable alternative for good returns.

Now that we find ourselves in a scenario of rising inflation, bond yields should rise in this regard, pushing bond prices lower.

This makes bonds less attractive and it can be argued that this once again leaves stocks as the only suitable alternative. It could also be argued that these inflationary trends could be transient, correcting the unprecedented shutdown mentioned earlier, and that once economies stabilize at steady activity levels, the forces of supply and demand will correct. and automatically stabilize the inflation level accordingly. Additionally, technological disruption has helped keep inflation relatively low throughout this decade, with digital innovation driving costs down.

A surge in inflation can also be seen as an indicator of the recovery in economic activity, a positive for companies and their prospects for profit growth. All of this leads us to the conclusion that “TINA” will continue to roll and stocks should continue to remain the most attractive asset class available to investors in order to improve their risk-adjusted returns within their diversified portfolio.

This does not mean that all stocks will outperform. During these times, the importance of selection is more critical than ever, in identifying areas of the stock space that will fare best in an inflationary environment.

This article is not, and nothing in it should be construed as a recommendation regarding any investment products or services offered by the BOV Group. All opinions, assumptions or opinions expressed in this article are those of the author. The value of investments can go down as well as up and may be affected by changes in exchange rates. Past performance is no guarantee of future performance.

Christabel Camilleri Saliba, Portfolio Manager, BOV Wealth Management