Please find below our latest investment market commentary, with this edition focusing on the topical subject of inflation. We continue to provide regular updates and further investment updates and observations to help support our clients.
Article written by Iain Lightfoot, Managing Director, Armstrong Watson Financial Planning and Wealth Management and Richard Cole, Fund Manager at Future Money Ltd. Building on these articles, Iain and Richard have also recently recorded a series of Quarterly Webinar Updates, offering an overview of the investment markets and looking at each of the Future Money solutions in detail. Watch Quarterly Updates
Inflation in the UK, as measure by CPI, has jumped to 3.2% for the 12 months to August 2021. The July reading was 2%, and, as has been widely reported, this monthly increase is the largest since 1997. Also, in absolute terms, a level of 3.2% is the highest annual reading since 2012. Such a surge is of course, noteworthy, but it is also unsurprising given the trajectory of inflation throughout this year and the state of the economy 12 months ago.
While the July reading of CPI was just 2%, in June the figure was 2.5%, May was 2.1%, April 1.5% and March 0.7%. As such, if the July figure is set to one side, the August figure can be seen as a continuation of a trend that began in early spring. This trend is also likely to continue over the coming months, with the Bank of England previously forecasting that inflation will peak at 4% towards year end. With this background, today’s announcement has been taken well by markets, with only a muted reaction occurring.
It is worth considering the path of inflation beyond 2021 and we will do that, but first it may be useful to review what factors are driving inflation higher currently. With inflation calculated by comparing prices now with those of 12 months ago, considering the conditions present at the start of the period is important. Such base effects can have a large impact on the reported numbers. In August 2020, the Eat Out to Help Out scheme provided government subsidised restaurant meals, which in many cases effectively halved the prices paid. As this was a temporary scheme and patrons must pay full prices once again, this is clearly inflationary in the calculation and has been referenced by the Office for National Statistics as a major factor in the current inflation numbers. Transport costs have also had a notable impact on inflation with fuel prices rising and the cost of cars increasing. From April to August 2021, the price of second cars increased by a staggering 18.4%.
Such rising prices are eye catching, but so far are not viewed as problematic by the Bank of England or financial markets. Both factors listed above are expected to be transitory in nature, i.e. short term. With Eat Out to Help Out only occurring during August last year, its impact will have largely cleared by next month’s inflation release. Second hand car prices too, are largely a result of the pandemic. Lockdowns and supply chain disruption have led to a global shortage in semiconductor chips, causing reduced availability in new cars, while concerns over close contact with the public have dissuaded people from travelling via public transport. While these issues will last longer than the food prices rises mentioned above, they are still expected to fade over time. If inflation is therefore expected to fall on its own accord, as most policy makers believe, there is little need to adjust monetary policy through higher interest rates or reduced quantitative easing. Hence why markets are unphased.
There is a risk to this complacency, however, and reasons to believe that inflation will not just disappear. While it is highly unlikely that we see a repeat of the above transitory factors, and therefore inflation is likely to fall after the winter peak we appear to be approaching, where inflation goes beyond early 2022, is much more uncertain. A renewed surge in prices is very possible and, should this occur, investment markets may well be more impacted. As an economy emerges from a recession and growth takes hold, an increase in inflation is a normal occurrence. Add into that typical scenario a ground breaking level of stimulus from global central banks and the potential for unusually high inflation is clear. A potential indicator of sustained inflation is in a number of ‘stickier’ measures, like wages. In such categories prices can be slow to rise, but once they do, they rarely go down. With unemployment low, and job vacancies high, there are signs that wage inflation may already may be on the way and early examples can be seen in some sectors already, such as in haulage given the shortage of HGV drivers.
Should persistent inflation begin to develop then the Bank of England will likely move more quickly towards higher interest rates, and this is where investment trends may become more challenged. Bond markets and equities with high growth rates have performed well over recent years as interest rates have fallen, and while any interest rate increases are likely to be small by historical standards, such a move would call into question their current high valuations. More likely to be successful in these conditions are less interest rate sensitive assets, such as short dated bonds and equities valued more on current assets than future growth rates.
The Future Money portfolios aim is to deliver inflation beating returns and therefore the path of CPI is a key consideration. Our expectations are that the current winter surge will not be game changing, but what happens into next year has the potential to be very important. Consequently, the portfolio allocations are positioned with an inflationary environment in mind.
Our philosophy is that no one can predict the peaks and troughs of financial markets with any accuracy and it has always been extraordinarily difficult to time when the best (peaks) and worst (troughs) are. Timing the stock market is extremely difficult, so we believe it is best avoided. Volatility is a part of investing which is why we always take time to understand how much risk any client is prepared to take before investing. We also generally believe in the benefit of diversification of assets to help manage some of the extremes of the markets. Taking a diversified multi-asset approach means that some assets can fair better in different market conditions as they are more defensive assets such as bonds, whereas during periods of growth equities tend to fair better.
Armstrong Watson, in addition to our full range of accountancy services, also have our own fund management expertise from the Future Money asset management team, as well as independent expertise from the wider market. We are able to use this to help provide insight, commentary, advice and support to our financial planning and wealth management clients.
A key aspect of our investment philosophy is that it is time in the market not timing the market, which is usually the best approach.
At Armstrong Watson, our quest is to help our clients achieve prosperity, a secure future and peace of mind. We believe that for those people who are considering taking financial advice now may be a good time to do so, whilst existing allowances and tax reliefs remain available, with the Autumn 2021 Budget now on the horizon.
Please note that the contents are based on the author’s opinion and are not intended as investment advice. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested.
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