After a rather stormy year for the stock market, a new threat has arrived to plague investors — inflation.
Britain expects a spending boom as lockdown restrictions ease. Last week, Bank of England chief economist Andy Haldane predicted the economy will grow at its fastest since World War II.
But experts warn that a surge in demand may spark a damaging rise in inflation. It was these concerns that saw world stock markets wobble last week.
Are markets right to fear inflation? What might it mean for your portfolio?
Spending boom: Experts warn that a surge in demand may spark a damaging rise in inflation. It was these concerns that saw world stock-markets wobble last week
Inflation is a stealth tax
Simply put, inflation means a drop in the purchasing power of money, meaning goods become more expensive.
Inflation is often called a stealth tax, as savings are worth less over time.
A little inflation is considered healthy for modern economies, but a larger dose is not.
The current fear is that surging post-lockdown demand, fuelled by unprecedented government stimulus, will raise prices globally.
In some areas this is already under way, with commodities such as copper and oil up 35 per cent and 36 per cent respectively since January. Consumer goods prices in the U.S. are at their highest since 2008.
Central banks have tools to tackle inflation, but these have consequences elsewhere.
Pushing up interest rates helps dampen demand, but makes borrowing more expensive – bad news for firms that rely on ‘cheap money’, like U.S. tech stocks.
It’s why Apple and Amazon both fell more than 2 per cent last Tuesday, with Tesla dropping almost 5 per cent.
Are fears overstated?
It’s important not to panic unnecessarily. Markets fret constantly about inflation, and dips like the one last week do occur.
This short-term noise is best ignored by those investing for the long term. If inflation does return, it may not be as bad as some fear.
‘Policymakers are saying that an inflation rise is temporary,’ says Laith Khalaf, an analyst with investment platform AJ Bell.
Crucially this would mean that central banks could let demand fall naturally, rather than cranking up interest rates.
Balancing act: Pushing up interest rates helps dampen demand, but makes borrowing more expensive – bad news for firms that rely on ‘cheap money’, like U.S. tech stocks
He still advises savers and investors to review their portfolio to assess how it might fare in an era of rising prices.
That means not holding too much in a cash savings account. With cash savings rates set to stay low, your money will lose value in real terms.
Instead, you might want to look at a mixed asset fund that offers a ‘one stop’ approach to investing.
BlackRock’s MyMap and Vanguard’s LifeStrategy range let you invest in a set portfolio that acts like a cash savings account.
The funds are highly diversified so shouldn’t be hit badly by sudden market moves, and contain defensive assets such as inflation-linked bonds.
How to shelter savings
How inflation might affect a portfolio of funds and shares is more complicated.
‘In the short term, an inflationary shock would likely hit stock prices across the market,’ says Mr Khalaf.
But in the long-run, he thinks shares offer a much better inflationary hedge than cash or bonds, and should recover.
Some sectors may even perform better if prices go up.
‘If inflation rises, it will likely be because the economy is running hot,’ says Rob Morgan, an investment analyst at Charles Stanley.
‘Companies sensitive to consumer spending — such as the previously embattled travel and leisure —might be well placed to benefit.’
This would suit funds like Franklin’s UK Mid Cap, which backs many customer-facing FTSE 250 businesses. It had a strong start to 2021, with a £10,000 investment five years ago now worth £15,800.
Rallying commodity prices would be good news for the FTSE’s mining and energy sectors. Rio Tinto, Anglo American and Glencore, are currently up 11 per cent, at 29 per cent and 32 per cent respectively since January.
For investors seeking a portfolio hedge, Mr Khalaf pinpoints BlackRock’s World Mining investment trust. It backs established, specialist mining companies.
A £10,000 investment five years ago would be worth about £29,200 now. But the trust isn’t risk-free, he says, due to the mining industry’s cyclical nature. Only a small part of a portfolio should be put in a trust with such a narrow focus.
As for gold, the historic safe haven, opinion is divided.
‘Gold doesn’t always work as an inflation hedge, especially when interest rates are rising,’ says Mr Morgan. But he does note that precious metals have kept their value over time.
iShares Physical Gold ETC is an easy way to invest in gold directly, with £10,000 invested five years ago worth £13,500.
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