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Inflation Conundrum

11 February 2022

There is no getting away from the fact that Covid has brought about a very unusual set of circumstances for the economy. The forced closure of many parts created a short but very sharp collapse followed by an equally sharp rebound as things opened up again. However, with workforces depleted by illness, death, isolation and even lifestyle changes, the entire world has seen product supply unable to meet the resurrected demand both at the manufacturing and the logistical and transportation levels. This unique set of circumstances was exacerbated by the further closures and restrictions imposed on bars, restaurants etc. Consumers had built up massive household savings over Covid and they wanted to spend. Much of the hospitality industry was unable to accommodate them, however, so the money was spent on additional goods instead, making the problems described above even worse. There is only one outcome to such a supply/demand imbalance – price inflation.

Similar manpower problems hit the energy industry but ecologically inspired underinvestment in oil and gas in the West, particularly Europe, made things so much worse. The UK’s energy strategy, if indeed one exists, has been chaotic. Gas storage was almost entirely closed some years ago so our emergency supplies are virtually non-existent. The release of the massive gas deposits upon which large areas of the country sit has been closed off to the fracking industry. Oil and gas reserves have been underexploited as the energy companies have sought to placate the ESG investment brigade. The oil price has risen considerably and the gas price has multiplied several times over. Putin’s war games add to the uncertainty. The inevitable outcome is energy price inflation.

The manpower shortages mentioned above have certainly led to a degree of wage inflation. We heard very early on of the bumper pay rises and bonuses in the transport industry and there will have been many more. Andrew Bailey, the Governor of the Bank of England, has come in for some stick this week for suggesting that employees should be circumspect in their wage demands. It probably wasn’t the cleverest thing to say at a time when families are struggling with massively increased fuel and food bills but, technically, he is correct. It is when it gets baked into the nation’s wage demands that inflation becomes a real problem. It wasn’t until Margaret Thatcher, in the 1980’s, broke the unions’ ability to hold industries to ransom, that her government was finally able to get on top of the nation’s long term inflation problem. The unions no longer hold so much power but the acute manpower shortages in some areas of the economy can have a similar effect.

So, we are at a point where these three separate inflation drivers are all pointing one way but the economy, having enjoyed an early sharp rebound, is at a very vulnerable point. Played correctly, the recovery of the economy post Covid could stretch out over several years more but too heavy a hand on the interest rate/QE tiller could kill it off very quickly. Manpower shortages are gradually working themselves out and as Spring approaches we can expect the gas and oil prices to ease a little provided, that is, there is no Russian invasion of Ukraine. It is also good to hear the head of the Oil & Gas Authority, the industry’s regulator, denounce windfall taxes on the oil companies. We need those profits invested to meet our future energy needs, not frittered away by bureaucrats. As the year progresses a number of the product price increases will drop out of the annual inflation figure and that would give the BoE’s Monetary Policy Committee pause for thought when considering further rate increases and quantitative reversals. The way forward should look a lot clearer as we enter the latter part of the year and, with luck, that clarity should see a lower peak to both the inflation and interest rate cycles than is currently being discussed.

Market Outlook

Recent weeks have seen a distinct rotation out of technology and into value. Some ratings in the tech sector had been grotesquely overhyped so something had to give and, with interest rates finally embarking on an upward trend, dividend paying alternatives have been sought. There’s a novelty! In truth, the technology sector has been ripe for a correction for quite some time but, each time it threatened, sufficient money was prepared to “buy the dip” to quickly reverse it. Increasingly expensive money finally broke that support. Whilst the likelihood of higher interest rates hangs over the market the search for value is likely to continue, in our view, and that should be good news for those invested for traditional returns via both income and capital growth.

However, we should not write off the technology sector. This is likely to be a correction, in our view, rather than a bear market. Investors are, however, likely to be a bit pickier with their selections and fund-raising will become more difficult for the “wing and a prayer” outfits. That’s no bad thing. Such corrections provide opportunities, of course, and we will hope to spot some for you. However, it could also be a good time to consider a technology focussed investment trust for those looking for a wider spread of risk to the sector. One that seems frequently to be overlooked by the media is Herald Investment Trust. This trust has a very successful record over the long term and has very wide international exposure to small quoted companies in the telecommunications, media and technology sectors, many overlapping two or all three. Its performance is top quartile over three years and second quartile over five. Despite this the shares, at 2020p each, stand at a discount of almost 14% to net asset value. That looks a good medium term entry point. Risk level is moderately high.

Retiring? Moi?

Not quite. You don’t get rid of me that easily. However, at the age of seventy and having spent fifty two of them in the stock market, I’ve decided it’s time to ease off the throttle a bit. From the end of March I will leave the everyday business to Stuart and Neil, ably assisted by Jo. I will still be around but your enquiries are more likely to be answered by one of them. “Thank goodness” did I hear? If nothing else it will leave me more time to write this stuff every month! Hopefully the knacker’s yard is still a few years away.


Russell Dobbs FCSI

Chartered Wealth Manager