With the global economy recovering strongly from the COVID-19 pandemic, inflation is increasing, and this can be costly for consumers, stocks, and the economy and it is one of the factors that may impact a portfolio. As a leading boutique fund manager, SG Hiscock offers a range of actively managed investment strategies specialising in Australian equities and property securities. Inflation’s varying impact on stocks tends to increase the equity market volatility and risk premium and high inflation has historically correlated with lower returns on equities. Read on find out more.

What is Inflation?

Inflation is a sustained rise in the price of goods and services in an economy.

There are two widely used indicators of inflation:

  • CPI (consumer price index) – measures the price of a basket of goods and services typically purchased by households, and so reflects price pressures faced by consumers.
  • PPI (producer price index) – measures the price of a basket of goods and services typically purchased by producers, and so reflects cost pressures faced by business.

Changes in these price measures is referred to as inflation. Rising inflation can be harmful; input prices are higher, consumers may lose purchasing power unless their incomes rise, and monetary policy measures to contain inflation can damage growth and employment.

High inflation can be good, as it can stimulate some job growth. However, high inflation can also squeeze corporate profits with higher input costs.

This can be confusing for investors, therefore it’s vital to sift through the confusion to make wise decisions on how to invest in periods of inflation.

Inflation Matters for Several Reasons

It can hurt economic growth to the extent it results in a rise in business and consumer uncertainty. Uncertainty as to the degree of price pressures to be faced, and the degree to which these can be ‘passed on’ to others through compensating increases in wages or prices, can cause a drop in consumer spending and business investment.

Inflation can also mean an increase in cost-of-living pressures for consumers. Higher inflation means consumers need to spend more to get the same amount of goods or services. Unless wages also rise in line with inflation, this can result in a lower standard of living.

Rising inflation can mean rising interest rates. This is because lenders usually want higher compensation to part with their money given that it will be able to buy fewer goods and services when returned in the future. Higher interest rates can place downward pressure on the value of some investments, such as high growth companies and those offering long-term income streams.

The Impact on Investors

Returns can be thought of in ‘nominal’ or ‘real’ terms. The nominal return is the actual rate of return in percentage terms. The real rate of return is the nominal return less the inflation rate.

While modestly rising inflation generally is seen as a positive for the broad share market, as it is consistent with an economy growing at a sustainable pace, inflation above a certain level, can be a negative.

Higher inflation is usually seen as a negative for stocks because it typically results in:

  • increased borrowing costs
  • higher costs of materials and labour
  • reduced expectations of earnings growth

When combined, these variables generally put downward pressure on stock prices.

Responding to Inflation

Inflation should cause investors to consider, or reconsider, their investing style, and the specific types of securities in their portfolio.

Value investing

This style tends to do relatively well during inflation. Unlike growth investing, value investing entails the practice of identifying and buying whose intrinsic value, as determined by fundamental analysis, significantly lags their share price.

Inflation Hedges

Besides opting for a value investing style, there are several types of securities that make wise inflation hedges. They include small-cap, dividend growth, consumer staples, financial and energy are showing up on many recommended lists. Real estate is another tried-and-true inflationary hedge. Real estate investment trusts (REITs), publicly companies that own real estate or mortgages, offer a way to invest in real estate without actually buying properties. An investment in commodities may be one of the most powerful inflation hedges. Investors can direct portions of the portfolios into commodities using futures and options contracts and through investments in exchange-traded funds and mutual funds.

Invest With SG Hiscock Today

Investing in the right managed funds can help you develop a portfolio that both reflects your goals, timeline, and risk profile as well as inflation. If you’re looking for a boutique fund manager who can works with you to ensure the best results possible, get started with SG Hiscock today. We can help you invest in the best emerging market funds or help you find the right Australian small companies fund that aligns with your investment goals. Contact us online or give us a call today.