Inflation is the risk we all face
The quantitative easing, which both the US and the UK are pursuing, is unprecedented.
It is without doubt the largest reflationary act in history. It has been instigated primarily as a counter to deflationary forces, but there is a fine line between doing that in the longer term and sparking off a bout of serious inflation.
Despite all comments to the contrary, there is a distinct possibility that we could experience inflation, which would cause all sorts of problems for investors over the longer term.
However we are taught to worry only about the short term and in this many investors are appearing bullish, particularly about equities and commodities.
Fear is falling on the markets and whilst investor blood pressures were rising very steeply last year they are now subsiding to the point where investors are again asking where they should be investing. With deposit rates at, or near, an all time low, putting cash here is not the solution. Thus there is likely to be a scramble for assets, especially those that can deliver secure returns — like Life Settlement Funds — irrespective of economic growth, or the lack of it and whether there is either inflation or deflation.
Whilst “austerity” is perhaps too strong a word to describe the economy going forward, it is highly likely to be a less frivolous one. We are less likely to buy a handbag at £700 for example, and more likely to buy something seen as more durable.
This behaviour will also, I think, be seen in the investor, who is likely to concentrate on essential stocks such as food, water and commodities.
Stocks that pay an above average dividend will also be sought, as will certain energy stocks. So things, using the stock ‘green shoots’ phrase, do in the short term appear to be looking better.
Beyond this, however, will be much harder to predict. There is a good chance that this temporary euphoria in the equity markets will be followed by the bout of inflation mentioned above. But would the onset of some inflation be such a bad thing?
One of the least painful ways of dealing with the credit crunch could, for example, be to let house prices rise so that a lot of the bad debt would then be written back into the banks’ balance sheets.
The downside of this would be that it robs investors of the value of their savings and pensions. But as a strategy, it could get a government out of trouble and has done so on many occasions in the past. This said, it would take time for this to happen and in the meantime the good “old lady of Threadneedle Street’s” target of 2% inflation, is unlikely to get much attention.
Taking all this into account then, where is the investor likely to find an inflation-beating investment? A lot will depend on the time horizon the investor has to work with and the exact goals they are seeking to achieve. In addition to the many suggestions mooted in recent weeks in this column, gold is as ever a generally good bet because of its defensive qualities.
Another serious consideration would be to get into investments that are not near the epicentre of the credit crunch. This means taking a hard look at where natural resources are plentiful and where there is growth — for example some of the emerging markets where the demographics are good and the population aspires to higher standards of living. Countries with high cash levels, well-managed economies and rising middle classes that are focussed on improving their own economies should all out perform both the UK and US.
In practice this means taking a serious look at what you currently have and judging what else is available that will fit both your time period and risk appetite.
One thing is sure — “easy” it is not going to be. The days when you could simply pile into a market on general good sentiment are over and you will have to be much more canny to make those profit targets.
Nicholas Watts is an independent financial adviser with Positive Solutions Financial Services which is regulated by the Financial Services Authority. To contact him, use the website www.realwealthmanagers.co.uk