Rising inflation and the impact on your investment strategy
21 September 2022
Globally, investment markets continue to demonstrate high levels of volatility as rising inflation strengthens concerns about a slowdown in global economic growth and potential recession.
The most recent inflation outcome in the US caught investors by surprise as the headline consumer price index rose 0.1% month on month versus expectations of a 0.1% decline. While this variance may seem negligible, it deflated the market’s hopes that US inflation had already achieved its peak, thus triggering a broad-based market sell off in bonds and equities.
It is reasonable to expect that US interest rates will now move higher than initially anticipated and finish somewhere in the range of 4-4.5% raising the probability of a recession in the US. Until interest rates near this level we anticipate that market volatility will continue to persist.
A setback? Yes. But a disaster? No.
While it may take longer for inflation to moderate, there are some positive indicators that suggest input prices (i.e. the prices that go in to producing goods and services) are easing, despite these not yet being passed on to the end consumer.
For instance, we know that much of the driving force behind rising inflation has been global supply chain disruption stemming initially from COVID-19 related lockdowns and more recently exacerbated by the ongoing war in Ukraine. While supply chain pressures remain elevated relative to historical levels, indicators such as the Global Supply Chain Pressure Index show that after reaching a peak in December 2021, these supply chain pressures have substantially eased (see Chart 1). Similarly, data compiled by the international freight company Freightos also reflects an approximate 45% reduction in global shipping costs1 over the course of the last twelve months.
Chart 1: Global Supply Chain Pressure Index
On the demand side of the inflation equation, increased consumer spending on discretionary and household items since the easing of COVID-19 restrictions has also contributed to a rising Consumer Price Index (CPI). As a result of this spending, the ABS reports that Australian consumers have heavily depleted their savings levels to a point that they are now near pre-pandemic levels (see Chart 2).
Chart 2: Household saving ratio, seasonally adjusted
This story is mirrored in the US where household wealth as measured by the Federal Reserve (see Chart 3) fell heavily in the second quarter of the year (i.e., ending 30 June 2022).
Chart 3: Change in US Household Net Worth
Consumers cannot continue spending their lockdown savings at record levels as interest rate rises start to bite and their overall household wealth declines. When consumer spending does begin to ease, economic growth is likely to slow, and unemployment is expected to increase both locally and abroad. Inflation is likely to begin moderating as a result.
So, what if we do end up in a recession? If history is any guide, recession will be accompanied by an easing in monetary policy, falling interest rates and rising bond values.
Technically, a recession can be over by the time it has been declared considering the backward-looking nature of the data used to make this assessment. Over the last half-century, the US has experienced seven recessions, ranging in length from 2 months (in 2020) to 16 months (in 2007-2009), as represented in grey highlight in Graph 4, shown below.
Graph 4: S&P 500 Index movement since 1973
Importantly, on each of these seven occasions, US shares (as measured by the S&P 500 index) began to recover during the recession even while the economy was contracting.
Regardless of whether we enter a recession or not, in the context of a long-term investment strategy, we maintain our philosophy that short or medium-term factors should not derail your long-term plans and current economic conditions do not alter this view. Your Financial Adviser is there to guide you during periods of uncertainty and to help you stay the course towards your long-term goals and objectives.
The Findex Investment Team, in conjunction with our asset consultant, State Street Global Advisers continue to monitor global investment markets and geo-political events and stand ready to make tactical adjustments to portfolios should the need arise. Now, however, we remain comfortable with current portfolio positioning.
As always, should you have any questions with regards to your portfolio or the market volatility please reach out to your Adviser or get in touch with one of our expert wealth management advisers today.