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Inflation – the silent assassin

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As the global inflation cycle turns up, how will this affect you and how can you guard against falling behind this silent assassin eroding your wealth.

Inflation is the increase in the price of goods and services which ultimately reduces your purchasing power. To maintain or increase your wealth, you need to grow your assets at or above the inflation rate. If not, you are getting poorer as inflation erodes your purchasing power.

For the past 40 years, global inflation has remained low with the assistance of strict global monetary policy and an improvement in general productivity.

Suddenly, inflation has spiked up (8.5% in the USA) sending panic through global markets as investors attempt to predict its future and consequences. The last large global inflation spike was in the 1970s, leading to a global recession and a decline in global markets. Will it be different this time?

In 1974, US inflation spiked to 12% and then 14.5% in 1980 largely due to the oil crisis, which saw costs rise to $140 /barrel. But the main problem was, the US Federal Reserve was very slow in raising interest rates to curb inflation, which lead to a prolonged period of high inflation, an economic recession and stock markets declining as much as 50%.

US inflation

US Inflation

Since the 1980s, global inflation has been maintained at fairly low levels as global central banks have worked closer together to respond quickly to rising inflation.

So, the question is: Will this current spike in inflation be temporary or permanent (+1 year)? The current fear is that inflation will be more permanent leading to higher interest rates for longer and the possibility of dreaded “stagflation”, high interest rates and low growth or recession, as per the 1970s.

Currently global inflation is driven by:

  • Supply chain disruptions
  • Abnormal monetary stimulus post-COVID
  • High consumer demand post-lockdowns
  • Commodity price spikes due to Russian sanctions
  • Reduced Chinese supplies as a result of recent COVID lockdowns

From the start of the year, 2022 global inflation forecasts have increased to 6.2% from 4.0% and global growth forecasts have reduced to 3.2% from 4.1%. What has changed in 2022 is the negative effects of the Ukraine invasion and the investment markets’ rising fear that inflation will be more permanent and hence higher interest rates will follow.

A better analysis is viewing core inflation, which excludes common supply-side shock forces, mainly food and energy, and gives a fairer reflection of longer-term prices.

US core inflation

US Core inflation

In March 2022, US core inflation spiked to 6.5%. The 60-year average is 3.6% and it peaked at 13.6% in 1980. The key metric for predicting more permanent inflation is wage increases, which in the US, have recently risen to 5.5%, well above their 20-year 3.3% average. Low unemployment rates in the US and Europe, currently 3.6% and 6.8% respectively, are adding to the risk of wage increases remaining high.

SA inflation is also rising

SA consumer (CPI) and producer (PPI) price inflation are currently 5.9% and 11.9% respectively and probably rising because of high commodity prices and a weaker Rand.

South Africa Inflation

As our inflation is currently mostly supply-driven as opposed to demand-driven because of the weak economy, inflation is unlikely to rise abnormally in the shorter term. The main risk is the negative effect on economic growth.

South Africa MPC

Inflation and investment markets

Higher inflation leads to higher interest rates, which is generally negative for equities, but more so for growth-orientated equities, such as Technology shares. The US FAANG (Facebook, Amazon, Apple, Netflix, Google) stocks are, on average, down 30% year-to-date versus the MSCI World Index down 16% and the JSE All Share Index down 11% in US dollars (7% in Rands).

Investonline has been warning about the risks of higher inflation

We have been recommending a global conservative investment strategy for the last two years as market growth has been fuelled by central bank stimulus.

Last year, we commented, “With historical high forward P/E multiples, markets are forecasting low inflation and low interest rates for an extended period, which we believe is unlikelySector selection is key favouring more defensive and value-based equities as opposed to expensive growth (FAANG) sectors that are highly vulnerable to interest rate increases.”

Currently, it’s all about US interest rates rising

This year, US interest rates have risen 0.75% from near zero. The market expects another two or three 50-basis point increases over the next six months, with rates peaking at 3%. But a more negative view is a high of 5%. Despite these expected sharp rises, US interest rates are still expected to be in a low range in line with the last 30 years.

US interest rates

US Interest Rates

Investonline Conclusion

The US stock market comprises 60% of the global market and is thus the major driver of global stock markets. History shows, that despite rising inflation, equities have produced long-term, inflation-beating returns.

US interest rates and S&P 500 performance

US interest rates and S&P 500 performance

Although spikes in inflation cause short-term market panic, to beat inflation and protect your wealth, one needs to have a reasonable allocation of their investments in equities. Equities have produced an average real return of 7% per annum over the last 50 years.

It’s critical that your investment portfolio has the appropriate equity allocation to suit your personal risk profile to achieve your lifestyle goals.

Speak with one of our Portfolio Managers to assist you. .

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