Has anyone noticed that prices, especially of food, are creeping higher and/or we are getting fewer/smaller portions for the same price?
While the initial fears are for deflation, owing to the Covid-19 pandemic-driven demand destruction and supply disruptions, we believe the scenario now unfolding is the opposite — inflation, cost-push inflation to be precise.
The world did not experience inflation despite very loose monetary policies in the decade following the global financial crisis. But this time, really, could be different.
China was the greatest deflationary ally, supplying low-priced products to the world, for the past two decades. However, we are seeing an end to this positive impact, no thanks to the worsening US-China trade war as well as rising labour costs in China.
Yes, global demand remains weak — but so does supply. Many smaller businesses — and some large ones — have closed and more will be permanently shuttered over the coming months. This will effectively reduce supply, at least in the short to medium term.
Notably, costs for businesses are rising owing to a confluence of factors, including logistic costs and supply chain disruptions because of the outbreak, trade conflicts and protectionism as well as additional safety and SOP (standard operating procedure) compliance measures. Per unit costs are also higher as a result of lower demand and sales — that may persist longer term owing to consumer behavioural changes — even as overheads are rising.
Businesses may be forced to absorb part of the higher costs for discretionary goods and services but for the more price inelastic food staples and necessities, the bulk of the increase in costs will be passed through to consumers.
To be clear, we do not think there will be runaway inflation since there remains plenty of slack in the economy, including high unemployment, in the aftermath of the pandemic. Rather, inflation will likely inch gradually higher with time.
More importantly, the end is (most probably) nigh for deflationary expectations. And when the tide turns, it could happen very quickly.
The inflection point, we believe, will come with the successful development of safe and effective rapid saliva tests and vaccines, sooner rather than later.
A quick and reliable test will enable many sectors, such as airlines and hotels, to effectively resume operations. This and/ or commercially available vaccines will lead to a smoother and faster recovery to economic normalcy, as opposed to the current stuttering reopening of economies.
Increased economic activities will, in turn, generate stronger demand — including for commodities — that will trigger and feed the inflationary cycle.
Case in point, the historic crash in the price of oil — a major input in economies — has been one of the key factors behind negative inflation numbers in the past few months. But oil prices have rebounded sharply from the lows, of around US$19 in April, thanks to huge supply cuts by the Organization of the Petroleum Exporting Countries and Russia.
Sentiment could drive prices higher if and when the return in demand over the coming months turns out to be faster than expected. We do not believe prices will be substantially higher given ample supply globally, though it remains to be seen how big the damage the pandemic-driven price collapse has inflicted on shale producers and oil majors. But the point is that the lows are very likely behind us.
If inflation — and more critically, inflationary expectations — starts turning higher, as we think it would, this would surely give central banks pause on further interest rate cuts. And there will be implications on current portfolio asset allocations.
For a start, there would be far fewer reasons to buy bonds, especially very low and negative-yielding bonds.
Central banks are set to keep policy rates very low for an extended period, to help the economic recovery process. The US Federal Reserve is prepared to tolerate inflation rates above its 2% target. It also recently poured cold water on speculations it would embrace a Japan-like yield curve control. On the other hand, there are huge fiscal deficits to be financed. The yield curve may soon start to steepen again.
The world has printed lots and lots of money to counter the pandemic, the bulk of which has gone into, and is reflected in, asset prices. A case in point is the current rally in stocks globally.
This asset inflation will go on. Additionally, we foresee an imminent rotation into cyclical stocks such as banks, where earnings are closely correlated to the broader economic health and would fare better with a steeper yield curve.
As inflationary expectations gain traction, demand and prices for real estate and commodities such as oil and gold will also rise. Commodity prices will be further supported by US dollar weakness.
To recap, we have already touched on each of these interlinked topics of vaccines, gold and US dollar trends in the past three weeks — culminating with this week’s final piece of the puzzle, inflation (see “A quick recap of our articles”).
US stocks continued to lead global markets higher last week. The Standard & Poor’s 500 index reached a new all-time record high, meaning it has now recouped all losses resulting from the Covid-19 pandemic sell-off that ended the previous bull market rally, and more.
Tech stocks stayed in the driving seat with the share process of Apple and Tesla surging to record highs. Apple is the first US company to breach the US$2 trillion ($2.7 trillion) market cap threshold — and is the most valuable public listed company in the world today — while Tesla’s valuation is now twice that of Toyota Motor Corp.
Of note, robust trading interest in Apple and Tesla spiked further after the companies announced stock splits. This is yet another instance when narratives, as opposed to fundamentals, are the key driver behind short-term momentum.
A stock split, on its own, has zero effect on the underlying value of a company. It is like breaking a one-ringgit note into five 20- sen coins. You are neither richer nor poorer for it.
The Global Portfolio finished strongly for the week ended Aug 27. Total portfolio value was up 5.5%, which lifted total returns to a fresh record high of 36% since inception. This portfolio is outperforming the benchmark MSCI World Net Return index, which is up 22.3% over the same period.
Tech stocks far outperformed the broader market. Shares for Adobe, Alibaba Group Holding and ServiceNow recorded double-digit gains, ranging from 11.6% to 14.4%, for the week. Alphabet and Microsoft were up 6.4% and 5.5% respectively.
Only the two building material stocks, Builders FirstSource and BMC Stock Holdings, ended in the red last week. Incidentally, the Wall Street Journal reported that the two companies are in talks to combine via an all-stock deal. There is as yet no official announcement at the point of writing.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
