Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

This past week had a slight air of nothing stays the same about it, as central bankers seemed to deviate, just a little, from their long held mantra of ultra-low interest rates and maintaining asset purchases at their current pace in support of the world economy.

First, Bank of England Governor Andrew Bailey alluded to rising inflationary pressures before a Treasury Select Committee on Monday, recognising some “very hot spots in terms of prices”1. Next it was the turn of the Vice Chair of the Federal Reserve Richard Clarida, who indicated in an interview with Yahoo Finance that the time may be fast approaching where the current pace of central bank asset purchases will once again become a topic for discussion2.

Meanwhile, China, following a month of strong gains and record commodity prices, announced it would strengthen price controls on iron ore, copper and corn3. Taken together, events of the past week add to the growing evidence we are now past the point at which we can disregard the inflationary impact of historically significant government stimulus programmes and a reopening of the world economy.

Investors with properly diversified portfolios may not feel the need to make adjustments in expectation of a rise in inflation, especially if that rise is set to be small or moderate and accompanied by a healthy bout of economic growth. It’s worth remembering that central banks – at least for now – remain wedded to the idea that any rise in inflation this year will prove transitory and that sustained price rises are at least another couple of years away.

A small or moderate amount of inflation is, however, generally a good thing for shares, if it enables companies to raise the prices they can charge their customers and spurs consumers to make purchases in the belief the prices they will have to pay for goods and services in future will be higher.

So now an important question for investors is, what kinds of companies can be expected to perform well in an environment like this? Companies with pricing power stand to, most certainly. Pricing power comes as a result of producing goods or services that consumers greatly desire or ones they feel they cannot do without. In that regard, owning strong brands or valued intellectual property can be critical attributes.

Arguably this applies to US tech giants like Apple, Amazon and Facebook, which were increasingly becoming a vital ingredient in our everyday lives before lockdown and have strengthened their positions ever since. It probably also applies to the industrial robotic arms makers, autonomous vehicle manufacturers and renewable energy producers of the future.

That creates something of a dilemma for investors. After all, the kinds of growth stocks driving changes like these are supposed to command a valuation premium – which they do. When the world economy in general enters strong growth mode and traditional companies can charge more for their products, that premium can begin to look more like a luxury.

It’s worth remembering that the march of technology is arguably a bigger trend than the expected cyclical upturn out of the pandemic. Technology will continue to drive improvements in productivity and new opportunities to create wealth whether the world economy is expanding or not. Meanwhile, there is little reason to expect a break in the long term demand upswing for branded and premium consumer products in emerging countries.

Trends like these suggest the divide between traditional beneficiaries of economic growth such as miners, construction companies, financials and high street retailers and the long term developers of the world of tomorrow will be more blurred than might more usually have been the case.

The demand for rare and precious metals arising from new vehicle battery technologies and stricter emissions standards for petrol and diesel cars may further muddy traditional lines drawn in the sand. Positive results from Johnson Matthey on Thursday – which showed clean air technologies driving a 30% rise in underlying operating profits in the second half of 2020 – underline how far technology and industrial processes have become intertwined4.

Expect to hear much more about profit margins if inflation does, indeed, continue to gather pace. While the economic growth likely to accompany a rise in inflation should help companies grow their overall sales volumes and profits, ultimately those businesses also able to keep a lid on input costs will have an advantage against the rest. Once again, a win, possibly, for companies able to turn technology to their advantage, as either producers or consumers of it.

Margins as well as trading volumes are already under the spotlight for builders’ merchants, after a year of brisk trading resulting from home improvements and repairs. A combination of rising commodity prices, shipping container costs and now shortages of building materials like timber and cement threaten the outlook. Last month, Travis Perkins said that it managed to raise its gross margin by a modest amount in 2020, but operating margins were already on the slide at its Wickes and Toolstation divisions (5.5% and 1.2% respectively)5.

The bottom line is there will be a diverse opportunity set for investors as government stimuli are put to work and the world progresses to a greener and increasingly technologically advanced tomorrow. This implies an improved environment for “value” oriented funds focused on traditional industries after an extended period of depressed returns brought about by ultra-low inflation and patchy demand.

It suggests as well more opportunities  for “best ideas” growth funds, aimed at pinpointing businesses growing consistently faster than the economy overall. Certainly, a combination of both types of fund in a portfolio could make sense for the vast majority of investors, enabling them to capture the superior long term returns of growth businesses while maintaining an exposure to traditional industries, either in the capacity of risk controllers, or as an outright means to benefitting from improving economic conditions.

Fidelity’s Select 50 list of favourite funds contains several UK funds with contrasting strategies. The Fidelity Special Situations Fund, is a long established value oriented fund. It seeks to invest in unfashionable areas of the stock market, but specifically companies undergoing positive change.

The Fidelity UK Select Fund approaches the market differently, emphasising businesses that have strong brands and robust balance sheets. Unilever, Next and Diageo are among the Fund’s largest investments currently.

The Select 50 list contains a number of ideas for fine-tuning an investment portfolio for higher inflation. The Ninety One Global Gold Fund invests in a diverse portfolio of gold mining companies worldwide. It also has the flexibility to buy physical gold ETFs and shares in companies that mine for other precious metals, and currently has a 4% exposure to silver6.  A few percent or so invested in gold could help to cushion an investment portfolio from the adverse effects of a large rise in inflation.

Another Select 50 choice, the FP Foresight UK Infrastructure Income Fund, offers an exposure to investment companies dedicated to renewable energy and infrastructure projects and targets an attractive annual income from its investments of 5%, although this level of income is not guaranteed. It also has the potential to work as a partial hedge against inflation, as the revenues from infrastructure assets are often inflation-linked.

Source:

Sky News, 24.05.21 
Yahoo Finance, 25.05.21 
Reuters, 25.05.21 
4 Johnson Matthey, 27.05.21 
5 Travis Perkins, 15.04.21 
Ninety One, 30.04.21 

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. The Fidelity UK Select Fund invests in a relatively small number of companies, so may carry more risk than funds that are more diversified. The Fidelity Special Situations Fund and Fidelity UK Select Fund may invest in overseas markets, so the value of investments could be affected by changes in currency exchange rates. The funds use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The funds may also use currency hedging. Currency hedging is used to substantially reduce the risk of losses from unfavourable exchange rate movements on holdings in currencies that differ from the dealing currency. Hedging also has the effect of limiting the potential for currency gains to be made. The Foresight UK Infrastructure Income Fund uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The fund also uses currency hedging. The Foresight UK Infrastructure Income Fund investment policy means it invests mainly in units in collective investment schemes. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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