The two-speed commodities play
This article first appeared on moneymarketing.co.uk on 28 September 2022 It really has been a...
We’ve been hearing a rather unfamiliar term being bandied about recently: stagflation. But what does it mean and how is it likely to affect our investments?
Stagflation is best defined as an environment of increasing inflation but low – or even negative – economic growth. This can also be accompanied by rising unemployment. It’s pretty much the worst of all worlds.
Those with long memories will recall how stagflation stalked the 1970s, when rising commodity prices led to spiralling inflation and falling economic growth.
However, the term is believed to have first been coined back in 1965 by Ian Macleod, economic spokesman for the Conservative Party, during a speech to the House of Commons. “We now have the worst of both worlds —not just inflation on the one side or stagnation on the other, but both of them together,” he declared. “We have a sort of ‘stagflation’ situation and history in modern terms is indeed being made.”
A period of stagflation is usually triggered by a specific shock that causes inflation to rise and economic growth to weaken substantially.
Often, this can be energy related. For example, a sharp rise in oil prices will not only push up inflation, but also cause problems for businesses. They will find their costs also increase in such an environment. This will impact on their profitability and could lead to them needing to reduce their expenses. This may in turn lead to them cutting staff. If a lot of companies go down this route, then the result is higher levels of unemployment.
Generally, stagflation usually only lasts for the immediate period surrounding the specific crisis. A prime example is the oil price shocks of 1973 and 1979.
However, stagflation can become a much longer-lasting phenomenon that endures well after the immediate impact of the supply shock has passed, according to Capital Economics. “This might happen if high inflation pushes up inflation expectations and/or kicks off a wage-price spiral, meaning that high inflation becomes ingrained in the system,” it said. “At the same time, weaker growth might persist because of the adverse effects of high and volatile inflation itself.”
This brings us to the present. Why are economists starting to float the idea that we could be poised to enter an environment of stagflation?
Well, it’s important to look at which elements needed for stagflation are already with us. Top of the list is inflation. No-one can deny that this isn’t present. Official statistics revealed that inflation – as defined by the Consumer Prices Index – is running at 5.5%, which is putting a strain on many household finances. The price of oil has also soared on the back of the Russia-Ukraine war, which means people are having to pay inflated sums to fill up their cars with fuel.
The situation in Ukraine has added a stagflationary twist to the outlook, according to the recent Economic and Strategy Viewpoint, published by Schroders. It now expects global growth of 3.7% this year and CPI inflation coming in at 4.7% – down from 4% and 3.8%, respectively, in November.
“Despite the changes to the global forecast, the risks are still skewed toward stagflation either through a wage-price spiral or an even greater escalation of the Ukraine crisis,” it stated. “The chances of rising prices triggering another recession, as in earlier cycles, have clearly risen especially as central banks have limited room for manoeuvre given the high level of inflation and lack of economic slack.”
Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International, agrees. “The main global economic fallout of Russia’s invasion of Ukraine is likely to be a stagflationary shock, as a result of severe disruption to commodity markets,” he said. “We think higher commodity prices are here to stay and will lead to both higher inflation and lower growth. This means the risk of outright recession in Europe is rising sharply, especially if physical commodity flows from Russia are substantially disrupted in the coming days and weeks.
“Policymakers are facing an unenviable choice between acting hawkish to get inflation under control at the risk of meaningfully damaging growth, and letting inflation run unchecked in order to protect growth as much as possible.”
The most attractive investments during periods of stagflation include those that have an inflation-linked element, such as properties that can increase rents. Similarly, companies selling essential items are well-placed as the demand for their goods is unlikely to fall, irrespective of the broader economic conditions.
Here we highlight a few funds that are either directly responding to the threat of stagflation or invest in areas that could survive such an environment.
This fund, which has been co-managed since its launch in 2010 by Matthew Page and Dr Ian Mortimer, provides global exposure to dividend paying companies as they are seen as outperformers in the long-term and can protect against inflation.
“Any disruption to oil and gas supply could have a material impact on energy prices, increasing the risk of a stagflation environment, i.e., one of slowing economic growth but high inflation,” the managers wrote in a recent update.
However, they remain optimistic. “We are confident from a bottom-up perspective that the companies we hold in the fund are well placed from a pricing power standpoint.”
Commodities generally perform well during inflationary environments and BlackRock World Mining Trust is a way of accessing this market. Its aim is to provide a diversified investment in mining and metal assets worldwide, actively managed with the objective of maximising total returns
In a recent update, the portfolio’s managers stated: “We are also seeing inflationary data increase and commodities have traditionally been a core way for investors to both protect themselves from this but also benefit from such trends.” They also emphasised where people should be investing.
“We believe the best risk-adjusted opportunity today is in the shares of mining companies in robust financial positions with strong balance sheets and high levels of free cash flow,” they added. “Mining companies are continuing to return capital to shareholders through dividends and buybacks.”
This fund invests in long income property which aims to deliver a consistent income stream from real estate let on long-dated, typically inflation linked leases for a period in excess of 15 years.
According to the fund’s March 2022 factsheet, around 94% of rent reviews are linked to inflation or have a fixed uplift, rather than being subject to open-market negotiation. Most of the rent reviews are also upwards only. This helps to provide some degree of clarity over future income, which is useful in the current environment.
“Throughout the period since the outbreak of COVID-19 in early 2020, the fund has continued to deliver a consistent income return from its portfolio, despite the unprecedented challenges faced throughout the UK,” the managers pointed out in an update.