My weekly preview Nr. 684

BUSINESS & FINANCE
INFLATION
EXPLAINED
Darryl Watt,
Ord Minnett
Buderim.
The lift in inflation this year has been a
source of concern for investors. Whether
inflation can be sustained at higher
rates, however, is the subject of much
debate.
Our base case is that some of the
recent price spikes are transitory. That
said, even with some easing in these
transitory factors (travel prices, labour
shortages and supply bottlenecks),
inflation is likely to settle at higher levels
than previously and is likely to be back
within central bank target bands. So,
how should investors approach this
scenario?
Equities are better placed to deal
with inflationary periods compared
with other asset classes such as cash and
fixed income. This is because inflation
normally implies stronger economic
conditions and because companies
can pass through higher prices to
consumers. So, in a healthy inflation
environment, equities should perform
relatively well.
A stagflation scenario – a
combination of slow economic growth
and relatively high unemployment
(stagnation) accompanied by rising
prices (inflation) – would be less
favourable for equities, but they should
still perform better than fixed-income
assets (where we are underweight) given
the latter’s returns are fixed and would
be eroded by inflation.
Within the equity market, rising
inflation favours cyclicals, while
defensive sectors are the ones that
tend to lag an inflationary cycle.
Major central banks have had
difficulty lifting inflation, and sustaining
it, since the 2007-08 global financial
crisis, if not before.
Australia’s inflation rate has been
on a downward trajectory, and until the
latest data for the September quarter,
had been below the Reserve Bank of
Australia’s (RBA) two to three per cent
target band. Meanwhile, at the extreme
end, Japan has been experiencing bouts
of deflation for a quarter of a century!
These scenarios came about despite
attempts by central banks to use their
monetary policy tools, in other words
interest rate cuts and quantitative easing,
to stimulate demand, and therefore
inflation, to within their target range.
This year, however, there has been a
noticeable upturn in inflation, led by the
US, where the core consumer price index
has already jumped from 1.6 per cent
year-on-year (YoY) to 4.6 per cent YoY. In
the euro zone, a similar measure has
risen from 0.2 per cent YoY to 2.1 per
cent YoY, while Japan has swung to
inflation of 0.1 per cent YoY from
deflation of -1 per cent. In Australia, the
trimmed mean consumer price index,
the RBA’s preferred measure, has risen
from 1.1 per cent YoY to 2.1 per cent YoY.
Darryl Watt is a representative of Ord Minnett Limited,
AFS Licence 237121. This article contains general
financial advice only and does not consider your personal
circumstances; you should determine its suitability to you.
Before acquiring a financial product you should seek
advice from a licensed financial adviser and consider the
relevant product disclosure statement. Past performance
is not a reliable indicator of future performance.
CALOUNDRA CAY
myweeklypreview.com.au My Weekly Preview | December 9, 2021 27