FMA Wealth Commentary – June 2022

This economic battle to tame global inflation is the fire underneath the continued market volatility. Inflation’s revival has always been expected after the dramatic and large Covid-19 impact (and resultant consequences) to the whole world; a near unprecedented event in the past hundred years. Yes, and since late last year, the recovery from all this is happening indeed, but just not happening smoothly.  Especially, inflation’s happening with a vengeance!

Having some inflation is regarded as being both positive and a normal feature within an economy. It implies there is growth and stimulus of activity in motion. However, with this present global recovery underway, it is becoming evident that inflation is at higher levels than central banks around the world anticipated, both in its size of increase and its speed of increase. Although it is commonly agreed that this current inflationary problem was seen to be more of a transitory symptom as the world adjusts back to more normality, the concern has now become when will the rising inflation halt, and will it fester longer and be more rigid to repel.  We all are seeing, feeling, and hearing about rising inflation for months now.

A major function of central banks is to manage inflation and, typically, to do this they adjust the monetary and bond levers. The Reserve Bank of Australia habitually likes to have annualised inflation in the 2% to 3% band. Not too little and not too much. If an economic slowdown beyond the RBA’s desired level for economic growth, it would likely ease official interest rates and pump more cash and liquidity into the system through bond buying coordinated programs, etc. During the critical Covid-19 period of 2020 and 2021, the RBA, and other central banks around the world, just applied ‘emergency measures’ and put the release on the handbrake down completely. Cash rates, bond rates near to zero percent. Unprecedented Government fiscal measures and cash ‘hand-outs’ also happened, as we know. All this combined, flooded the economy with cash and liquidity, and thereby avoided what could have been disastrous economic and social outcomes otherwise. All in all. it seemingly worked for its purpose.

However, with cash at its cheapest level ever, and large amounts of household savings and many businesses with healthy cash holdings in their balance sheets, this all was inevitably going to spark inflation as the recovery and more economic and social normalisation re-emerged. However, other factors too, as will be noted below, have turned ‘up the heat’.

Many central banks around the world are now being criticised for acting too slowly in not raising interest rates earlier (which they began to do a few months ago), and also for not been quicker to cease quantitative easing measures (pushing cheap money into the economies). It probably is a fair criticism of central banks, and of governments too, as inflation has now burgeoned.

But, gee, the past two or so years have been a battle for successful economic management amidst the closures, lockdowns, shortages, deaths and illness, travel bans, etc. triggered by the Covid-19 pandemic. And we must remember that it is easy to be critical of events and the actions taken because of them, when reading about them through the eyes of history!

When asked by a commentator after not winning a close PGA tournament whether he should have used a different approach to an important shot that fell short of the green; the Irish golfer, Shane Lowry, responded with his big smile and simply said “Er, sure, hindsight is genius, isn’t it!”.  So true, so true.

Okay, so now, the converse situation is in play now. Central banks are front-loading interest rate rises to ensure that inflation has peaked or at least close to peaking. Possibly another criticism is that they should have gone in with larger quantum of rate rises initially but there are also other variables and headwinds in play (life is never simple!). The central banks know they must hike up rates at a quicker pace, as they most certainly will do, to create a more normalised financial environment from its current pressures. We are in interest rate rise mode, as we know, and bond yields continue to rise across the yield curve.

Equally, central banks and governments must manage the quantum and timings accurately enough so they can respond quickly by having capacity to reduce rates, etc. to avert stalling the economies. Flexibility management is important as they desire to achieve the old ideal ‘soft landing’ approach to avoid unintended recessionary outcomes.

So just why is inflation so rampant at present?  I have outlined below the fundamental reasons for this rapid spike in inflation around the globe being a combination of numerous factors occurring together, and which is, in culmination, causing the prolonged market volatility around the globe:

• Consumers and businesses are broadly flush with cash/savings creating excess demand for goods and services. Such heightened demand is causing price rises. Disposable incomes are still at high levels and, therefore, spending by consumers remains at a rapid clip, as the world has, to the great part, ‘re-opened for business’!
• Economic growth on a broad global basis remains strong so there is also ‘normal’ growing demand taking place.
• Slowness in central banks active responses to curtailing the obvious outbreak of inflation. Anyway, this is now being tackled by actual aggressive global rate tightening.
• Most economists did not foresee the degree of inflationary rise. In saying that, several factors involved were not known or had not been on the radar as they have emerged in recent months e.g. the Russian/Ukrainian conflict.
• Covid induced trade, transport and travel restrictions causing supply side constraints, this ‘less supply availability’, with increased demand pressures, creates price rises.
• Near full employment (also because of virtually no new immigration here for two years) induces capacity constraints, thereby causing wage increase pressures.
• Businesses which suffered downturns in trade and activity over the past couple of years simply charge more now as part of their ‘catch-up’ strategy and ‘we should’ philosophy.
• The Russian invasion and despicable war on Ukraine causing massive oil and gas price rises, and now also food delay shortages and resultant price rises.
• China is the biggest exporter of goods in the world, however, its extreme zero-Covid lockdown policy which it forced upon its citizens because of its ineffective homegrown vaccine, has caused massive supply shortages, and has meant supply ships and containers sitting idle for many weeks’ which is adding to bottlenecks in the global supply chain.
• High demands for Commodities and Resources being very strong, and now seeing some record prices in key ones. Fortunately, Australia is blessed with being the ‘lucky country’ with its abundance of natural resources, including energy, and its high food production output. So, economically this is good for Australia and its exports. Australia’s GDP outlook remains strong.

Looking through the above list it is no wonder that inflation has risen, and particularly so most notably in the past few months. Australia’s own official annualised inflation rate is over 5%, however, most things that we buy or services we use appear to have risen in price more than that, I am sure we all agree! The US inflation rate is now at over 8% annualised.

It certainly seems that persistent inflation will remain for a while more, and the markets will likely continue their volatile actions until inflation is capped and reduced, and to what extent further interest rates rises will be taken.

It is a rough ride for investors at present, and there likely will be further frustration, but we do know what is happening and why it is occurring. We also know that many of the above issues will be solved with time, and with directed central bank, Government, and corporate policy measures. We also know that global economic growth remains positive, and the evidently good corporate earnings now and forecasted ahead, also support this brighter picture.

Yes, this stemming of inflationary pressures must be, and is, at the forefront of action being taken. Yet, the markets do overreact, especially when frenzied traders and media meddlers are involved, as they always are in such times. Uncertainty in the short-term can be challenging, as it is what is impacting current weakness in the markets. However, with a long-term outlook by investors, and a reminder that with long-term solid economic fundamentals being relevant, the current volatility can and is presenting very good opportunities to add quality growth and income assets to investment and superannuation portfolios.

As I see it, and practice it myself, by having belief, implementation and commitment as a defined strategy when owning and building a quality investment portfolio puts true investors on the path to achieving their financial goals over the long-term.

Speaking of superannuation, do remember that any superannuation ‘top-up’ contributions for this financial year must be completed within the next couple of weeks’.

As always, should you have any queries please do not hesitate to contact us.

Disclaimer for information provided in this Commentary: This document, and the contents contained within, is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, or plan feature. The views expressed in this are subject to change at any time. No forecasts are or can be guaranteed.