Inflation is the highest in over 40 years and the Bank of England forecasts a rate of 13% in October
Breaking News 8th June 2022
Breaking News 8th June 2022
This inflationary surge is something new for most. The people making investment decisions on behalf of clients have likely never seen these phenomena, and as alluded to last quarter, we are deep into a fundamental regime change.
More uncertainty than usual ahead?
The chart below tracks the Bank of England Base Rate (the traditional economic lever to control inflation) against UK inflation as measured by the Consumer Price Index. The theory being higher interest rates lowers inflation. Enter the Great Financial Crisis of 2008/9 which confounds that theory.
During the last decade, interest rates hit never seen before lows and money was printed to support the economy. Inflation remained below the long term average.
Investors today hear that CPI is well above 9%, but how should this dramatic acceleration be interpreted?
A trick of the light
The impact of inflation can feel muted because we see charts like one below showing how the annual rate of inflation has rocketed, but then falls back quite quickly according to (hopeful?) forecasts, theoretically alighting on the Bank of England's 2% target - We suspect inflation will be more like 2.5% per year over the long term.
The real impact is the shaded blue area showing how the value of £100 in 1988 has eroded to less than £30 due to inflation's effects.
Things won't get cheaper - they'll just get expensive less quickly.
It is all relative…until it’s not
The ARC Indices suggest the average portfolio was worth over 10% less at the end of June compared to the end of 2021. Add in another 10% of inflation and the purchasing power of your money has dropped by a fifth.
Investment managers might rightly point out that, relative to benchmark or peer group, your portfolio has outperformed. But people don’t buy things with relative performance; people spend real money.
So what? I'm a long term investor, markets always come back. Don't they?
We make assumptions every day. There are a wealth of studies on decision making and cognitive biases showing ultimately, we are all irrational beings trying our very best to be rational.
It will not be fine because it feels fine now.
What we know now changes previous assumptions quite dramatically. Real growth is challenging, inflation is difficult to forecast and markets are volatile, all of which adds to the fog.
I wasn't concerned before but I am now, what should I do about it?
For the three scenarios above, we suggest
Inflation is bad for our financial health and these actions may feel like an uncomfortable and temporary sticking plaster. However, taking no action could be disastrous.
As ever, your friendly ARC Consultant remains at your disposal.
If you'd like to speak to Grant about anything in this months CIO notes, please feel free to contact him below