Summer typically marks a change in stock market mood. After an intense period of company results, annual reports and AGMs, news becomes less specific. Instead broader factors like inflation, politics and currencies grab the headlines. Investors have time to pause and consider overall market themes and portfolio strategy. After a strong run in companies that should be boosted by the return of inflation, is it time to look again at growth businesses?
Inflation can create new winners, but the recent stock market move has been rapid and possibly indiscriminate. Investors have so far mainly focused on surprise; the potential for further overshoot of inflation expectations allowing even bad businesses to pass on prices. That is a complete change from the pattern of the past two decades, where big old economy companies faced relentless disruption and a downward spiral on prices.
Meanwhile, growth now looks less special and investors discount its future more heavily. Growth businesses – previously prized for their long term earnings and power to raise prices - are worth less when long term interest rates are high. Many of these companies performed well in 2020, but in recent months have been sold by investors to capture the opportunity in cyclical sectors more exposed to the economic recovery of this year.
But now more serious thought begins. Market opinion is finely balanced between transient inflation and the possibility of it becoming embedded and racing away. Few were investing in the 1960s, so the lessons of history may be forgotten. 60 years ago inflation began slowly and was initially well received by stock markets, reflecting strong economic growth. But it took two decades to bring price rises and interest rates back down.
Investors should think more about the impact of supply bottlenecks, de-globalisation, sustainability and politics. Some of this may prove transient, but the world might be in the early stages of some powerful new themes. There is potential for much change in the global economy, but possibly in a different direction than the exceptional circumstances of the pandemic.
Indeed, the supply restrictions that have triggered sharp price increases, may be solved over the next 18 months. Disinflationary forces remain, not least within the EU. But it might take longer to address inequalities that have worsened during the pandemic, or to build on the popular mood for a sustainable economy. There may be long term opportunity for companies supporting resilience, sustainability and reduction in fossil fuels.
It is surely too soon after a great economic shock to bet on supply shortages beating the powerful long term forces of technology and demographics. Indeed, these very shortages and price rises may spur increased capital investment, finally turning round weak productivity growth. And markets should not assume that the US lack of concern on inflation means inaction by all central banks.
This year may bring an interest rate rise by the Bank of England, ahead of the US Federal Reserve. Brexit has triggered more bottlenecks in the UK economy and its successful vaccination programme has spurred a sharper bounce in the economy than in much of Europe. The key to whether inflation is transient or not will not be found in wage inflation. If the Bank of England acts, the Pound would likely strengthen – cooling the economy a little but favouring domestic businesses over international earnings.
The narrative of inflation and a rotation into ‘value shares’ has driven some share price moves that may prove unsustainable. A more balanced approach to investment style may now be prudent. The summer months could bring some surprises on currencies and action to fight inflation. Within the economic changes of resilience, productivity capital investment and sustainability, opportunity remains for growth businesses.
A version of this article was published in The Herald on 12/06/2021.