Inflation – Transitory or sustainable?

Inflation – Transitory or sustainable?

09 November 2021Reading time: 5 minutes

During times of increased inflation, investors should diversify their portfolios accordingly. In addition to looking for markets with relatively low rates of price increases, the focus also lies on equities that could benefit from higher inflation.

ECB, Fed & Co in the hot seat

The word “Transitory” can be seen as the word of the year, at least when it comes to the language chosen by many representatives of the world's most important central banks. This means that in the eyes of most monetary policy makers, the price increases observed recently are not of a sustainable nature and high inflation should soon be history. However, analysts at BCA Research believe that for the time being, any declines in inflation rates should be short-lived. Accordingly, labor shortages in many sectors should lead to rising wages. Rents are also expected to rise, especially in the USA. Moreover, the ECB had to concede that price increases in the coming years are likely to be higher than initially planned. European monetary policy makers have already raised inflation expectations for 2021, 2022 and 2023 at their September meeting.

In addition to some effects concerning the German VAT cut and disrupted supply chains, the sharp rise in energy prices has contributed to the increase in inflation. In view of the approaching winter, the developments on the gas markets are being viewed critically. According to Michel Sale, Head of Commodities at Vontobel Asset Management, various aspects have contributed to the price increases on the gas market in Europe. Domestically, for example, people have struggled to fill gas storage facilities. A late cold spell last winter and an exceptionally hot summer in southern Europe, combined with higher cooling demand, had caused low levels. Furthermore, ESG-focused policies add pressure, while renewables are not ready to meet energy demand.

To make matters worse, a lack of long-term gas supply contracts meant that European energy producers had to bridge supply gaps by accessing the spot markets and paying higher prices in the process. Higher inflation, especially regarding energy prices, has put central banks under pressure. The ECB had to adapt its strategy to the new situation and subsequently unveiled it at the beginning of July. The new strategy envisages a symmetrical medium-term inflation target of 2 percent. Before, inflation was supposed to be "below, but close to, 2 percent." The implications are far-reaching. Similar to the Fed, the ECB can now accept inflation rates above 2 percent for a longer period without having to intervene. This provides more flexibility, but possibly also a longer-lasting loose monetary policy, which in turn could drive inflation again.

A good figure

Investors can respond to higher inflation in various ways. Which measures are appropriate depends on the level of inflation, but also on the markets or categories of goods that are particularly affected by inflation. For the month of September 2021, the U.S. Department of Labor reported a year-on-year increase in consumer prices of 5.4 percent. In the eurozone, the annual inflation rate in September was 3.4 percent and for the whole European Union 3.6 percent, according to Eurostat. Nevertheless, these levels were still below the price increase in the United States. In response, investors could now shift and reduce the proportion of U.S. stocks in their portfolios in favor of European equities. This way, they would be exposed to lower inflation. However, in view of the increased inflation on this side of the pond, this strategy needs to be supplemented or adjusted.

Next to an increased diversification of the portfolio with the help of markets with low inflation, the focus should also be on different sectors or companies. Especially since there are a number of companies that perform well in times of increased inflation. These include companies in the commodities and energy sectors. After all, they benefit from higher prices at gas stations, for electricity, gas or heating oil. Prices are also boosted by a shortage of many goods as a result of global supply chain issues. This development can be observed in the freight shipping industry. Capacity has been reduced as a result of the COVID-19 crisis. Now that demand for many goods has jumped surprisingly quickly as a result of the economic recovery, there are not enough ships and containers. Companies in the commodity and energy sector are not the only ones who can navigate through times of higher inflation.

Strong brands

Companies with a strong brand and high market share are in the right position to offer protection in an inflationary environment. Although they too must cope with higher raw material and energy costs, for example for oil and gas, they can pass on rising costs to customers through price increases. This means that consumers do not immediately stop consuming the respective products when prices rise. The probability of switching to cheaper competing offers is also relatively low. However, for this to happen, the respective companies must offer consumers a product that they do not want to abstain from, even in economically difficult times.

Such companies include consumer goods giants such as the Swiss food giant Nestlé, the U.S. beverage manufacturers PepsiCo and Coca-Cola, or Tech company Apple. These and similar companies score well with many strong brands or have become huge brands themselves over time. In addition, they have a worldwide presence, so that diversification can be achieved in multiple ways. Should some brands or markets weaken, these negative effects can be offset by successes in other product areas or parts of the world. The many strong brands and their strong presence in many markets have enabled them to survive a number of economic crises as well as periods of increased inflation.

Companies that generate a significant portion of their sales as market leaders in concentrated lines of business should be able to better withstand inflation.

Vontobel Inflation Influenced Index

Investors do not have to go on a lengthy search for equities that could perform well in times of higher inflation. The Vontobel Inflation Protection Index was compiled with a view to companies that have relatively high pricing power in their respective regions. To identify which companies have pricing power, the index focuses on companies that generate more than 50% of their sales as market leaders in lines of business with low competition. In addition, gross margin is an important indicator in equity selection. Companies that can pass costs on to consumers should still be able to achieve attractive gross margins by raising prices. Since inflation is constantly changing, the composition of the Vontobel Inflation Protection Index is not static. Considering the respective regions, the composition changes depending on the level of inflation. Three scenarios have been defined for which index changes are made.

The first scenario is when no region experiences an unusual increase in inflation. If a region shows a rapid increase in inflation, the allocation adjusts for the second scenario: Regional Inflation. If there are two or more regions, the index allocates to provide protection against global inflation. In the base scenario (no inflation), the Vontobel Inflation Protection Index consists of 60 percent U.S. stocks and 15 percent European and Monetary Union (EMU) equities, while Japanese stocks and Swiss stocks have a weight of 15 percent and 10 percent, respectively. At the same time, the focus is on the pricing power. In the regional inflation scenario, the respective shares of the regions with an increased inflation rate are each reduced by 20 percent. Corresponding to this reduction, the share of regions with low inflation increases. In the global inflation scenario, the pricing power component of the index is reduced to 80% in favor of a 20% diversified commodity component.


28/09/2023 19:53:35


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