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The drivers behind the low inflation of the past three decades are changing
Thursday 07 Oct 2021 Author: Daniel Coatsworth

The inflation story is not going away. In recent sessions we’ve seen an increasing number of companies talk about pressure on profit margins from rising costs and they are going to do everything they can to pass that on to the end customer.

Investors must therefore think hard about their portfolio and how it might be affected if inflation keeps rising.

While supply chain issues have been a key driver for inflation, many central banks continue to take the view that these pressures are transitory and will soon sort themselves out. However, it’s not that simple. Instead, it is worth thinking about the changing forces behind inflation as they arguably point to higher prices for longer.

Jerome Powell, chair of the US Federal Reserve, recently talked about three disinflationary forces. First is demographics, such as the growth of people in places like China; second is globalisation, where cheap Chinese goods have achieved a greater share of the market, thus bringing down prices; and third is technology where the internet has brought more price transparency and made it harder for companies to raise prices.

Peter Spiller, fund manager of Capital Gearing Trust (CGT), argues that these three forces are the old regime and we’re now seeing different drivers for pushing prices up or down. For example, he argues that demographics are shifting as the working population is diminishing, so this is losing strength as a deflationary force.

In Spiller’s view, there are two or three components to the new regime. First is green inflation, where governments are spending big on green infrastructure. ‘Taxes are also disappearing on petrol and I anticipate they will be replaced by carbon taxes which will go straight to inflation. The current energy situation is also inflationary,’ he says.

The fund manager also believes there is structural change such as Brexit is causing inflation. Lorry drivers aren’t going to enjoy £60,000 salaries permanently, but they are unlikely to go back to old levels once the current supply chain crisis abates.

‘The consensus is that the high rate of inflation will diminish. I think that is right,’ comments Spiller. ‘But the medium-term inflationary pressures are sufficiently strong.’

In times of rising inflation, energy stocks, real estate investment trusts and consumer staples businesses are considered good places to put your money.

Energy stocks benefit from rising commodity prices, a key driver of inflation. Real estate investment trusts own property and provide a partial inflation hedge by pushing up rental charges and potentially enjoying an increase in the value of their assets. Consumer staples sell products we need daily, so this is arguably non-discretionary spending.

Investors might also want to look funds which have a quality tilt. For example, Fundsmith Equity’s (B41YBW7) fund manager Terry Smith likes companies with high gross margins.

A business with a high gross margin can deal with cost pressures a lot easier than one with low gross margins, and there is a bonus on top if they are able to pass on higher costs to the end-customer.

DISCLAIMER: The author has a personal investment in Fundsmith Equity

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