The Inflation Conundrum

Prices are on the rise. Energy, food products, and industrial commodities are putting pressure on budgets from multinational corporations to pensioners alike. Inflation is often referred to as a hidden tax, as it slowly erodes the purchasing power of savings. For that reason, awareness of inflation and strategies to blunt its impact are crucial to successful investment outcomes.

Ipswich Investment Management’s (IIM) strategy has always been focused on achieving real, inflation-adjusted, asset value and income growth in client portfolios. Execution of this strategy is challenging in an environment featuring negative global interest rates and both cost-push and demand-pull inflation. While the specter of inflation threatening purchasing power is cause for concern, we can be thankful that global economic stimulus has thus far kept us from a pandemic-generated deflationary abyss.

However, the notion that we are in a post-pandemic health and economic recovery is perhaps premature. The development and successful deployment of COVID-19 vaccines is a monumental step in the war to end the pandemic, however, the original prediction that the pandemic would run for 1,500 to 2,000 days remains valid. We are not at the finish line just yet.

Thus, we can expect more disruptive variants to emerge, challenging the public health sector and potentially causing further economic disarray. This remains a global challenge and is not unique to any particular country. Herein lies the fundamental challenge in stamping out broadening inflation, which is fast becoming a global economic pandemic capable of inflicting significant regressive damage on people and fomenting new political stresses.

The global stimulus response has to date transferred some 15% of GDP to deficit financed transfer payments without addressing the ongoing needs being generated by inflationary expectations. Inflation is now a global problem, thus beyond the reach of any single central bank. A coordinated response is necessary, yet severely lacking from global leadership.

The current trends driven by a surge in energy prices, goods shortages, declining labor force participation, and now Cost-of-Living Adjustments (COLAs) will likely continue to broaden inflations impact, creating a new set of monetary and fiscal challenges in many countries.

Action by central banks prevented the worst economic damage as we entered the pandemic through coordinated response, but they have failed to adequately address the rise of inflation. A new approach is needed to dampen inflation before the window of opportunity becomes too narrow.

Concerted effort by central bankers is needed to support capital inflows into sectors that can deliver improved productivity and innovation and increased employment while reducing flows that support financial engineering and excess leverage, both of which do little to stimulate job creation and real economic growth. Margin controls, which have not been used in decades, may have a positive role in this regard.

At IIM, we concentrate our work on identifying leading businesses focused on new norms with excellent prospects for growing productivity and free cash flows. These naturally lead to strong returns on invested capital and high dividend growth. While these equities may be priced dearer than some more staid businesses, we expect the excess return will go a long way towards keeping the portfolios we manage ahead of inflationary pressures.