By Jacobus Lacock
The cost-of-living crisis has impacted consumers across the economic divide, but globally, it’s the lower-income households that will be the most affected.
Rising costs in fuel, food and energy will result in the poorest 10% of the world’s population parting with more of their disposable income, while the richest 10% will see only a slight impact on their disposable incomes.
For example, in the UK, the poorest 10% spent around 11% of their disposable income on energy last year, and this will rise to 50% of their disposable income over the next year unless respective governments step in to cushion the financial blow on families. Meanwhile, the richest 10% will see the 1% they spent on energy rise to 6% over the next year.
Statistics from the United Nations show that a 10% rise in food prices will trigger a 5% fall of the poorest families’ incomes, which is roughly what those families would normally spend on healthcare, raising fears that the crisis will see an increase in neglect of physical and mental health as households forgo medical treatment in favour of heating their homes and feeding their families.
Role of Central Banks in the crisis
Central banks play a vital role in ensuring economic and financial stability. Their mandate is to ensure price stability globally while keeping inflation low and stable.
Central Banks cannot afford for inflation to spiral out of control. If this happens, there’s a danger that prices will escalate uncontrollably, leading to hyperinflation. In this scenario, consumer prices for goods and services rise too fast for their wages to keep up, which leads to widespread poverty and political instability.
Unfortunately, central banks may have to make some unpopular choices, such as hiking interest rates to levels where demand will be destroyed. This we feel is necessary to manage the current demand-supply imbalance that’s resulting in higher inflation.
It will result in an overall growth slowdown worldwide, an increase in the cost of borrowing and could potentially lead to more job losses as the global economy navigates a classic stagflation environment, which may persist in waves of variable intensity for a few more years.
Inflation to remain high
Globally, we will turn a corner with some countries already close to hitting peak inflation. The US, for example, is one country where inflation is in the process of peaking and is gradually slowing. The European Union (EU), however, may still be some months away from hitting peak inflationary figures.
Pandemic related supply pressures are fading, but the global economy is still fragile, particularly as there’s still a war between Russia and the Ukraine.
However, there are some positive signs, such as the Ukraine gaining back some territories formerly occupied by Russia. Geo-politically, it seems like conditions for a ceasefire are building.
While growth concerns in China continue, this may be a good thing for inflation as the weaker demand there provides some offset to the inflation problem in the rest of the world.
Our prediction is that inflation may come down more broadly over the early part of next year but will remain sticky and higher than central banks’ targets. As a result, we are likely to see high global interest rates for many years to come.
Investing in a high inflation environment
It would be prudent for investors to reassess their investments in conjunction with their financial advisers to ensure that portfolios are invested in assets that offer protection against a global stagflation environment.
Not many investors have been around since the last time we had an inflation problem which occurred during the 1970s and 1980s. The world has changed a lot since then, with China playing a bigger role. The 70s and 80s were very volatile periods, and what tended to work then – investing in commodities and real assets – could work today.
Energy supply is severely constrained while demand will continue to hold, so investors should consider exposure to energy producers and commodities used in generating electricity. At current level, US government bonds can provide a hedge against slower growth. Equities should not completely be ignored. They are likely to be volatile and move sideways for a prolonged period but will rally when inflation falls from high levels unless we head into a severe recession.
Gold is one commodity that’s typically invested in to hedge against inflation.
You need to think of asset classes that will do well during stagflation and high inflation periods. We don’t think gold has been as defensive as it could be, but year to date, it’s still done better than other asset classes such as global bonds, global equities and listed property.
Portfolios constructed around countries that are more resilient to inflation, commodity producers or that are further down the road in terms of the hike cycle, such as South Africa and China, could deliver when looking for potential growth with attractive valuations.
Jacobus Lacock is a fixed income portfolio manager of Fairtree.