What the picture above shows is that in the US, inflation has drastically increased in the end of 2021, but the American central bank, the Federal Reserve, is yet to adjust the so-called target rate. If inflation stays high, the Fed is bound to increase it, which could be a challenge for equities.
The ultimate financial pickle
When we call inflation the silent assassin of cash, it is because that is exactly what it is. Inflation means the increase in prices in society over time and is an important measure for how society – financially – is evolving.
But even though it is seen as an important and positive part of the global financial infrastructure today, it is less positive for large cash reserves and savings. Because when prices increase it means that you can buy less for your savings. Let’s look at this example – you have saved up 10,000 USD to buy a new car. The car you want costs 10,000 USD, but you decide to wait a year to have a bit of buffer. Next year – if inflation is at 2 pct. – the car will instead cost 10,200, so if you haven’t saved 200 USD dollars more, you can’t afford the car anymore. While 200 dollars in a 10,000-dollar budget might not seem like a lot, the compound price increases over time can be significant. That is why banks in general will advise you to invest your money, as the potential positive return you might get over time can help you keep your purchasing power.
But what do you then do in a situation where your cash savings are being killed by inflation faster than usual and the equity market seems to be trending down at the same time? “Generally, it is probably time to revisit what is called your asset allocation. This means the mix of investment assets like stocks, bonds, etc. as it could be time to move some money from equities into other instruments,” Garnry says.
You can get more inspiration from our Chief Investment Officer, Steen Jakobsen’s, 100-year portfolio here, where he looks at how a more inflation-prone portfolio could look.
If you have a long time horizon and still think equities is the way for you to go, some sectors seem better suited than others when interest rates increase and where uncertainty roams the financial landscape.
Looking at his own equity baskets, Garnry sees large discrepancies: “What you need to look at when evaluating stocks at a time like this is whether their valuations seem too high. I believe that growth pockets like e-commerce and bubble stocks will continue to suffer, as will tech-sectors due to the continued semiconductor-shortage, whereas I believe crypto, logistics and semiconductors might be winners. Apart from that, a situation like this generally suggests that high-quality, usually very large companies will do better than smaller ones,” he says. To see more about which equities have performed well during the recent inflation, read this article.