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Inflation is here …

Investment market update (for the quarter ended 31 May, 2021)

There is no doubt we will see higher reported inflation this year. In fact we’ve already seen it – grabbing headlines last month (at least in market circles) were the various US’ April inflation reads.

The Personal Consumption Expenditures (PCE) index (the Federal Reserve’s preferred measure of inflation) was up 3.6 percent, the highest level in over 12 years.

Excluding volatile food and energy, core PCE was still up 3.1 percent, the first time it has started with a “3” since 1992.

… but is inflation temporary, or will it be sustained?

In our view, we generally agree with central banks that many of the current inflationary pressures are short-term factors.

The long-term forces that kept inflation low pre-Covid – ageing populations, high debt levels, fast pace of new technology development – are unchanged.

That said: (1) the extent of monetary (low interest rates, quantitative easing, aka money printing) and fiscal (government deficits) stimulus has been unprecedented and the longer-term effects remain uncertain, and (2) justifying the current extreme policy settings will only become harder if economies continue on their current healthy trajectory.

Jump in bond yields

Year-to-date, longer-term interest rates have firmed reflecting the improved economic outlook and higher inflation risks.

For investors who plan to own bonds to maturity, these “losses” on bonds aren’t permanent – holders will still receive the same interest on their investment and be repaid in full when the bond matures (unless, of course, the borrower defaults).

Equities continue to perform well

Despite the jump in longer-term interest rates, it has still paid to remain invested in equities.

Global equity markets have continued to push higher with companies generally delivering better-than-expected results benefiting from a combination of improving economic activity and significant cost savings.

New Zealand has remained a laggard

For over a decade the New Zealand equities market has been amongst the strongest in the world. Year-to-date, the position has reversed.

The New Zealand market is dominated by defensive dividend-paying stocks, which many investors look at as an alternative to fixed interest investments such as bonds or term deposits. The rise in long-term interest rates has generally been a headwind for these stocks.

Furthermore, the NZX50 market index is concentrated in a relatively small number of companies — the largest eight companies account for around half the index. What that means is any price changes (up or down) in these larger stocks has a significant impact on the overall index.

Keep expectations in check

We still advise investors to stick to healthy weightings of risk assets (shares, property) in portfolios, particularly given the low interest rates available on cash and bonds.

We do acknowledge though, there is every chance we could see volatility across the market or within specific sectors or asset classes, impacting portfolio values.

With uncertainties ahead, ensuring you have adequate portfolio diversification (always a mainstay of any investment plan) may prove even more important than usual.

Your Forsyth Barr Investment Adviser is always available to discuss your investment plans at any time.

This column is general in nature and does not take any of your personal circumstances into account. For personalised financial advice, contact Forsyth Barr for an overview of the services we can provide.

Brett Bell-Booth
Investment Advisor with Forsyth Barr Limited in Tauranga. Phone: (07) 577 5725 or email brett.bell-booth@forsythbarr.co.nz

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