Prices, picks and the pandemic

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There’s no doubt what the big investment story is at the half-way stage of the year. As the chart below shows, on either side of the Atlantic, if less so elsewhere in the world, consumer prices are on a tear. The key question is not whether inflation is making a comeback but whether its return is just a rebound from last year’s economic shock or something more serious.

Inflation: taking off?

Source: Refinitiv, 30.6.21

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. Investments in emerging markets can be more volatile than other more developed markets.

 

There’s plenty of ammunition for the inflation hawks right now. Whether you look at consumer prices in America and Britain or factory gate and commodity prices in China, the data are a worry. Anecdotally, too, there’s no shortage of stories about businesses struggling to find the right workers and having to pay up to secure them.
But the numbers can be lined up to make the counter case too. Strip out the biggest outliers in the data and the averages look less alarming. Inflation might only be half the recent headline rate in the US. Globally, there are still too many workers for the jobs available. Job creation at the current rate won’t fill the gap for at least a couple of years.

Looking back in time for guidance is less than helpful. The 1970s is the principal template but the world was very different then. Inflation was caused by a massive supply shock in the form of the Arab oil embargoes that fuelled the vicious cocktail of low growth and high prices known as stagflation. Today’s price rises are a consequence of recovery and growth. That’s a very different kind of problem.

But the inflation doves, particularly in America, are taking some risks. Joe Biden is pushing through spending plans that will deliver a federal deficit of nearly 17% this year and 8% next. That’s a huge experiment, aided and abetted by the Federal Reserve’s unprecedented monetary accommodation.

Central banks are showing the same signs of complacency that they demonstrated under an earlier Fed chair, Arthur Burns, fifty years ago. He chose to dismiss the elements of the inflation basket that were rising inconveniently fast. It was a fatal error that required bold and painful intervention by his successor Paul Volcker. No-one wants to see a repeat of the early 1980s recessions.

Why does inflation matter? It is rightly described as a hidden tax - that’s why governments like it in moderation. Even moderate inflation, however, can be devastating to our wealth over time. Prices rising at just 4% a year will cut your purchasing power in half in only 18 years. With longer retirements in prospect, you need to have put aside a great deal for that not to matter.

There’s plenty of ammunition for the inflation hawks right now. Whether you look at consumer prices in America and Britain or factory gate and commodity prices in China, the data are a worry. Anecdotally, too, there’s no shortage of stories about businesses struggling to find the right workers and having to pay up to secure them.
But the numbers can be lined up to make the counter case too. Strip out the biggest outliers in the data and the averages look less alarming. Inflation might only be half the recent headline rate in the US. Globally, there are still too many workers for the jobs available. Job creation at the current rate won’t fill the gap for at least a couple of years.

Looking back in time for guidance is less than helpful. The 1970s is the principal template but the world was very different then. Inflation was caused by a massive supply shock in the form of the Arab oil embargoes that fuelled the vicious cocktail of low growth and high prices known as stagflation. Today’s price rises are a consequence of recovery and growth. That’s a very different kind of problem.

But the inflation doves, particularly in America, are taking some risks. Joe Biden is pushing through spending plans that will deliver a federal deficit of nearly 17% this year and 8% next. That’s a huge experiment, aided and abetted by the Federal Reserve’s unprecedented monetary accommodation.

Central banks are showing the same signs of complacency that they demonstrated under an earlier Fed chair, Arthur Burns, fifty years ago. He chose to dismiss the elements of the inflation basket that were rising inconveniently fast. It was a fatal error that required bold and painful intervention by his successor Paul Volcker. No-one wants to see a repeat of the early 1980s recessions.

Why does inflation matter? It is rightly described as a hidden tax - that’s why governments like it in moderation. Even moderate inflation, however, can be devastating to our wealth over time. Prices rising at just 4% a year will cut your purchasing power in half in only 18 years. With longer retirements in prospect, you need to have put aside a great deal for that not to matter.

2021 fund picks

When I picked five funds for 2021 I did so with three principal themes in mind: sustainability, income and what I thought was the unjustified underperformance of the UK stock market. Making my choices in November, after the announcement of successful vaccine trials, I also weighed up the likelihood of a rotation from the growth-focused shares that had led the pack for so long.

Six months into the year - and remember this is far too short a time period to draw any really meaningful conclusions - I’m pleased that I covered so many bases. The transition from pandemic to the new normal was never going to be a straight line and we have seen plenty of twists and turns along the way. Investing is rarely an either/or situation and so spreading our eggs around a variety of baskets - whether that’s in terms of assets, geography or investment styles - will always be prudent.

For most of the first half of 2021 the two UK fund picks have outperformed. This does not surprise me. The UK market is both cheap and well-placed to benefit from a pick-up in activity. In that regard, it’s also not surprising that the more cyclical, value-focused of the two funds, Fidelity Special Situations, has performed better than the more defensive choice, Fidelity UK Select.

The sustainability theme has clearly struck a chord with investors as the inflows to ESG-focused funds have been strong so far this year. I view sustainability as more a marker of quality than anything else, so I’m very happy to have a weighting towards ESG as a risk-management tool if nothing else. The Brown Advisory US Sustainable Growth Fund and the Stewart Investors Asia Pacific Leaders Sustainability Fund both look good still.

As for income, comments from central banks on both sides of the Atlantic confirm that interest rates are going to stay low for some time to come. In that regard, the yield target of the Foresight UK Infrastructure Income Fund, and the reliable source of its income streams, make it a good long-term investment story.

If you are not familiar with this year’s five picks, you can read more about them and watch interviews with all five managers. Look for ‘5 ISA picks for 2021’ under the funds tab at www.fidelity.co.uk.

A decent start to the year

Source: Morningstar, 30.6.21 bid to bid with income reinvested in GBP terms. Excludes initial charge. Figures rebased to 100 on the chart as at 1.1.21

%
(as at 30 June)
2016-2017 2017-2018 2018-2019 2019-2020 2020-2021
Fidelity Special Situations 30.6 8.2 -2.9 -19.6 36.0
Fidelity UK Select 20.6 7.7 4.4 -12.1 25.3
Stewart Inv Asia Pac Leaders Sustainability 14.5 8.5 7.2 1.9 26.4
Brown Adv US Sustainable Growth - - - - 24.9
Foresight UK Infrastructure Income - - 19.0 2.5 5.7

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. Investments in emerging markets can be more volatile than other more developed markets.

Paying for the pandemic

The dust is starting to settle on the pandemic, and we are beginning to get a sense of its impact and its economic and financial consequences. It is not a simple picture because Covid highlighted many differences and inequalities. Just as the coronavirus affected people’s health in very different ways, so the pandemic has not treated us all the same way.

The good news is that the impact of the pandemic appears to have been less than that of the financial crisis. We entered Covid with lower debts and stronger banks. Crucially, the steps taken by governments to protect people’s jobs and incomes ensured that a big drop in economic activity did not feed through in the same way into individuals’ financial situations. Here in the UK, in the second quarter of last year, GDP fell by more than 13% but household incomes by only 3% on average.

For many, the pandemic enabled us to save more. The chart below shows how the relatively stable savings rates in developed countries spiked higher in the lockdowns of both last year and this. For less fortunate people who spend a higher proportion of their incomes on essentials like food and heat, and whose jobs are more vulnerable, the past 15 months has been a very different story.

That will have important long-term consequences. It is no coincidence that speculation has risen in recent weeks about the measures that the Chancellor may be considering to claw back some of the gargantuan amounts of money he has thrown at supporting the economy during the Covid crisis. Unsurprisingly, the measures he is most drawn too are those which target wealthier cohorts. And the perennial favourite - pension tax relief - is back on the radar.

The way pension contributions are taxed makes them disproportionately favourable to higher earners. This is what makes a raid on pension tax relief so politically appealing - targeting people who are rich by most standards and redirecting the money saved to younger people and lower earners makes intuitive sense to a cash-strapped Chancellor.

Of course, we have heard these rumours before, and they have come to nothing as successive inhabitants of number 11 have moved them to the ‘too difficult’ tray. But forewarned is forearmed. Now would be a good time to look carefully at your tax situation ahead of the Autumn Budget in November and perhaps to take some financial advice.

Burning a hole in our pockets

Source: Refinitiv, 30.6.21. Household savings, percentage of disposable income.

Sustainability - right thing, right price

Taking account of environmental, social and governance factors is not an investment fad. The way that we think about allocating our money is changing for good, in both senses of the word. And sustainability matters to us as investors because it has both an ethical and a financial implication. Companies that score well on these three issues tend to be better companies, so doing the right thing for the world really can also mean doing the right thing for our portfolios.

However, the two things are not tied together by divine right. While we should all hope for a world in which companies behave honestly and in the best interests of all their stakeholders and the world they inhabit, we should not invest in them with no heed to the fundamentals. ESG is just as susceptible to over-exuberance as any other investment theme.

The chart below shows what can happen when investors get ahead of themselves. Renewable energy accounts for a massively greater share of the mix than even just a decade ago. It is a remarkable investment opportunity. That does not mean it cannot also be a bubble at times. The correction in share prices in recent weeks shows how risky it can be to chase the latest hot story.

Those of us who want to put our money to work to achieve both acceptable returns and a better world have our work cut out. Two hurdles stand in our way. First, the still glaring lack of consistency in how we measure, or simply talk about, ESG factors. Until there is better agreement on what good looks like in environmental, social and governance terms, there is a risk that the blind will be leading the blind.

Second, as ever when an investment theme is hot, unscrupulous actors will see an opportunity in our well-meaning credulousness. Greenwashing is an ugly word, but it describes a tendency to exaggerate, if not actually to mislead, that we must all be wary of. I’m suspicious of attempts to put numbers on companies’ ESG credentials. There is no substitute for the hard work of understanding a fund manager’s intentions when it comes to sustainability and checking their claims against the reality of the businesses they invest in.

ESG: over-exuberance

Source: Refinitiv, 30.6.21, total returns in USD

%
(as at 30 June)
2016-2017 2017-2018 2018-2019 2019-2020 2020-2021
World Renewable Energy Index 10.0 -2.3 19.3 55.0 109.2

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment.

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