Inflation has become the hot topic recently and has been mentioned a number of times on these pages over recent months. The resurgence of this phenomenon has been laid at the feet of the pandemic and, although this is partially true, to gain a full picture we need to take into account the severely deflationary impact that China has had on the world over the last thirty years. Their vast cheap labour-force allowed them to become the world’s workhorse and, as a consequence, advanced economies re-sourced product that had previously been manufactured domestically, leaving their own workforces with little power when it came to wage negotiation. Technological advancement also played a part in killing off inflation and, from the UK’s perspective, so did the importation of cheap labour from eastern Europe.
Jump forward to the present and we have something of a perfect storm reversing that long term trend. At the centre of this is China where President Xi Jinping is quite emphatically reversing many of the policies established by his predecessor and, in so doing, is fostering mistrust of China as a source of cheap and reliable products. Thirty years of China-induced global deflation has come to an end and that is going to be a long-term reality. On top of this we have shorter-term pandemic led inflation. This has manifested itself in several ways:
Central bankers have, as widely reported, declared the current bout of inflation to be transitory although over recent weeks they have sounded less certain. They are probably right to a degree. The bottlenecks will resolve themselves as will the manpower shortages in certain industries, but it will take a while. In the UK the temporary loosening of the immigration rules for some crucial workers will help a little but, as Paul Daniels loved to say – not a lot. Inevitably though, most of these inflationary inputs will drop out of the CPI/RPI after twelve months due to the simple fact that they are rolling annual measures. However, although technological advances can be expected to continue their long-term downward pressure on inflation, the globally deflationary impact of China is a thing of the past.
Central bankers, including our own, have adjusted their inflation forecasts from emphatically transitory a few months ago to somewhat less transitory now. Consequently, their interest rate rhetoric has hardened and, in the UK for instance, some are now looking for a rate increase later this year. Our guess is that, if it comes, it will be tiny. No central bank is going to want to kill off the recovery, especially when that recovery is already showing signs of fragility. Recovery in the advanced economies has been weakening quite drastically and this, in itself, will ultimately take some of the heat out of the inflation figure.
We said last month that the central banks in the West, having begun to look very wrong with their “transitory” view, could be right by default as the slowing economy does the job for them. It will probably, therefore, be seen as a wrong move if they now start to raise interest rates in the face of that slowdown. The Bank of England could be the test if it does decide on a rise soon. If the markets are convinced that inflation is transitory then they are likely to ignore any tiny interest rate rise, expecting further action to be unnecessary.
Our view is that much of the pandemic induced input will, indeed, be transitory but that the non-inflationary decades are now behind us. We anticipate inflation peaking at less than the 5%+ that many are now expecting but certainly more than the modest levels central bankers initially envisaged. Interest rates are likely to lag the inflation rate as economies are allowed to warm up again and we anticipate a modest but ingrained inflation rate of 3% or so to continue for some years. The BoE’s 2% target will likely be quietly forgotten.
Unilever’s Hidden Value
If Unilever’s third quarter figures, released this week, show us anything, it is its ability to cope well against an inflationary background. Underlying sales growth was a modest 2.5% but even this beat consensus analysts’ forecasts of 2.2%. It managed to increase prices by an average of 4.1% and squeezed product costs with such actions as simplifying packaging. It maintained its margin guidance for the year against the consensus of a small decline.
Unilever’s share price has been on the slide since mid-summer having fallen from over £48 to less than £39 currently, at which price it is valued at just below £100bn. It has recently put its PG Tips and Liptons tea division up for sale and four parties have expressed interest. It is expected to go for at least £4bn. Unilever’s range of brands is enormous, over four hundred, in fact, including Ben & Jerry’s and Walls ice creams, Alberto Balsam, Badedas, Bovril, Brylcream, Carte d’Or, Dove, Lynx and many more. The company is constantly reviewing its range and further disposals are likely as it focuses more towards wellbeing and healthcare. We feel there is hidden value in many of these lines.
Unilever is probably too big to think of as a bid target but not for activist investors, who can make a nuisance of themselves with comparatively modest stakes. Pushing management to take action to create better shareholder value they can quickly garner support from other shareholders. Unilever looks vulnerable to such a possibility whilst the shares are at such a depressed level and, in the meantime, a sustainable income yield of almost 4% is very attractive. They look a decent core holding.
Russell Dobbs FCSI
Chartered Wealth Manager
