Take advantage of inflation fears

Take advantage of inflation fears

Fear of reemergent inflation peaked earlier this year, coinciding with a surge in US ten-year bond rates to 1.745 per cent at the end of March. While bond rates have eased slightly (now 1.61 per cent) they remain persistently and materially higher than at any time in 2020. Part of the reason remains lingering concerns about inflation.

Most recently, analysis by Bank of America reflected on some US factors such as the increase in the federal minimum wage by noting the number of times ‘inflation’ has been mentioned during company earnings briefing calls is up 300 per cent year-on-year.  According to BA, this is the largest spike since 2004.

Economic theory says that the stimulative increases in money supply around the globe should lead to an increase in inflation. Witness, for example, the global pressure on prices for mineral commodities, metals, timber, agriculture and food, as well as shipping costs.

Domestically, some commentators are pointing to corporate evidence of rising prices. The Montgomery Fund owns Reliance Worldwide, which earlier in the week noted it was able to pass through to customers the ten-year highs in copper prices.

Online retailer Kogan recently referenced higher shipping costs, which came a week after Mineral Resources said labour costs were rising amid a dearth of truck drivers.

But both the US Federal Reserve and Australia Reserve Bank have poured cold water on the idea, that inflationary pressures are stubborn, and insist there won’t be a need to raise rates any time soon.

To this point, Australian economic data revealed a weaker than expected consumer price index at just 1.1 per cent for the year.

Coles Group recently revealed food prices fell 0.2 per cent during the March quarter and they fell 0.6 per cent with fresh food and tobacco excluded. Coles’s CEO Steven Cain noted a perfect growing season is keeping fruit and vegetable prices down, while the stock shortages of last year amid panic buying are now absent.

There is little doubt in our mind that inflation expectations are rising as lockdowns end, vaccines are rolled out and economies reopen. But central banks have explained that rising expectations are insufficient to prompt them to shift their dovish policy settings. They require a sustained increase in actual inflation before they are willing to start lifting rates.

And on that score, we believe that any spike in prices as a consequence of reopenings will be short-lived for a number of reasons.

First, consider that sustained inflation requires wage growth. Even before the pandemic, with employment at higher levels than we currently see, price rises had been persistently muted. As the RBA’s Guy Debelle told me, “we cannot expect two per cent inflation without two per cent wage growth”. And slack labour markets, which were a feature of economies prior to COVID, due at least in part to automation, remain in place.

The second point relates to automation, or technology and software. The significant investment in technology, which itself is the result of very cheap interest rates forcing investors to look for something to invest in, has driven the marginal cost of delivering many goods and services down. Consequently, the structural pressure on prices is downwards.

For investors this is very good news. Markets will always find something to invest in. That is what they do. We believe investors could take advantage of any future panic related to inflation, by investing with some confidence that central banks will needs to see wage inflation before interest rates start rising at the short end of the yield curve.

The Montgomery Funds own shares in Reliance Worldwide and Coles. The Montgomery Small Companies Fund owns shares in Mineral Resources. This article was prepared 07 May with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade these companies you should seek financial advice.

MORE BY RogerINVEST WITH MONTGOMERY

Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.