Inflation: From simmering to a boil

Inflation is an age demographic phenomenon; ask anyone with a vintage pre 1980s’ versus the younger set. To a lesser extent is inequality.

The case for the former is growing, and notably too the number of investment groups that are discussing the topic. Unlike central bank accommodation and deleveraging post the financial crisis, this time central banks are much more likely to allow rates to linger at very low levels and there is little sign of a major restructuring in debt to contain household or business behaviour. Mortgagees, for example, are being encouraged to interest only loans, rather than pushed to increase their equity or realise the property. Corporations may be raising capital but rarely is it to repay debt, instead it is to ‘bolster balance sheets’ (sit on cash) or pursue growth at a very low cost to capital.

The extent of cash sitting around could well be captured into higher prices, even if there is spare capacity.  There are other ways to get inflation to rise. In the 70’s and 80’s it was commodities (oil) and then the CPI linked wage formulas that created a spiral of price rises.

Today these are unlikely. The probable sources lie within redesign of supply chains and regulation that lead to higher costs.  Monopoly and oligopoly power have also substantially increased. The recent example is Apple and Google restricting access to game provider Fortnite due to their unwillingness to move on the 30% app store transaction fee. Why should any intermediary be able to strip such a large percentage if it where not able to dictate prices? Such structures take a long time to break down.

It is safe to assume many service costs will rise in coming years. Aged care and education are obvious. Regulation also challenges others, such as the financial sector due to the Haynes commission. No argument about its findings, rather that it requires additional operating standards.

The performance of the gold price implies there is a level of discomfort with fiscal policy. Assuming some return to normal activity in 2021, this could unleash a large amount of pent up demand alongside little incentive to restrain price movements.  A small movement in bond prices and inflation protected securities should be watched with care as it could herald a major shift in attitude that will rumble through all asset classes.

On inequality, this is not a high brow argument on the rights and wrongs of an individual’s position on society. What is self-evident is that there has been a growing divide in wealth. Older demographics with the tail wind of property and financial assets can, and to a large extent have, accumulated a nice nest. For anyone younger looking to enter the property market without BOMAD ( bank of mum and dad) and expecting the extent of real returns in financial investment (ignoring possible incompetent advice), the likely path suggests nothing like the past few decades.

The near-term impact on investment portfolios is not evident. Yet it is worth contemplating a relatively large cohort trapped into low spending power or a response from governments via income redistribution and regulation of some low wage industry sectors.

Where it already has been an influence is in politics and its shaping of global economics. People experiencing hardship can coalesce behind policies that lie dormant. The battle on global trade is currently the best example. COVID provided cover for a while, but the longer-term repercussions are yet to come.

Giselle Roux

Giselle Roux is one of Australia's most well-known and highly regarded investment strategists, having held the role of Chief Investment Officer at both Escala Partners and JB Were. She has also held a number of senior equities analyst and investment banking roles including with Citigroup, Bank of America Merrill Lynch and McIntosh Securities. Giselle is a host of Inside Network events, a member of the Advisory Committee and regular contributor to the Inside Adviser and Investor publications.