A discussion on inflation

Nader Hamid, Portfolio Manager with TWM Group at iA Private Wealth presents our video. You can also see this video in French presented by Jean Hénault by clicking here
Inflation has undoubtedly been a hot topic this year, and we’re all feeling its effects, from the gas pump to the grocery store to buying airline tickets. With the onslaught of daily headlines pointing to difficult times, we want to provide you with some information regarding inflation and, more importantly, in part 2 of this video series, how the TWM Group invests in this type of environment.

Economic cycles go through ups and downs, both of which are necessary for a healthy economy. And although uncertainty and volatility can sometimes be unpleasant, investors and companies with a strategic mindset have historically survived and went on to thrive despite the environment.

Inflation is currently the most significant determining factor central banks are using for hiking interest rates. 

Where is all this inflation coming from? Let’s start by looking at four major structural inflationary forces. 

Inflationary forces. 

1. Deglobalization trends 

For the past ten years, the world’s biggest economies have progressively leaned toward protectionism. You might be surprised to learn that the peak of globalization was identified all the way back in 2009. You’ve seen recent indications of this in: 

  • The Trade War between the US and China.
  • Tariffs between former allied nations.
  • Medical supply constraints during the COVID-19 pandemic.
  • The energy crunch, caused by the Russia-Ukraine conflict.

As a result, international trade has decreased, and countries turned to domestic suppliers for commodities, materials and energy sources. Often these suppliers have higher prices than their foreign alternatives, as well as the need for more inventory. But these inconveniences are being tolerated for national interests. In other words, a shift from “Just-in-time” to “Just-in-case.”

Another factor impacting inflation trends is poor government and central bank policies. 

2. Monetary policy: Interest rates have been too low for too long

You can see from the chart how rates were lowered after the Great Recession of 2008 and were kept low despite a strong recovery and continuing booming economy. 

Low-interest rates tend to produce inflation and asset bubbles. So why did we only see moderately higher prices until recently? Well, inflation may not have been present in consumer goods, such as food, cars and services; instead, they were present in assets, such as real estate, the stock market and other investable channels.

3. Monetary policy: Low investment in energy production

Global investment in energy infrastructure has decreased since the price of oil collapsed in 2014. The reality is that fossil fuels still serve 80% of the world’s energy demand, but the price volatility and their unpopularity related to their heavy carbon footprint have led to development stagnation. On the other hand, clean energy hasn’t reached the level to service the demand, which is continually increasing worldwide. 

The high capital expenditure and time needed to bring production back in line with long-term demand create a very sticky inflationary force and, unfortunately, will take several years to work through.

4. Housing and the Great Recession’s aftermath

Since the housing bust in 2008, home building has only just resumed its previous trend from over a decade ago. Naturally, after homebuilders got burnt, they were reluctant to reinvest. 

The glut in inventory has created an imbalance between demand and overall supply. Sellers and renters have been able to raise prices significantly. 

The impact on inflation has been material, as shelter costs make up a large portion of the headline number.

In addition to these long-term structural forces, other recent exogenous shocks have exacerbated inflation.

As discussed previously, the COVID-19 pandemic and the ensuing global government response brought about: 

  • Massive fiscal stimulus.
  • Very accommodative monetary policies.
  • People’s reluctance to go back to work.
  • Certain asset price bubbles. 
  • Supply-chain distortions. 

All of these contribute to upward price pressures. 

And if this wasn’t enough disruption, the war in Ukraine, in addition to the humanitarian consequences, has produced a price shock to energy, food and essential commodities.

Deflationary forces

On the flip side, are there any deflationary forces at work? Of course.

There are opposing structural forces that complicate the investing landscape – here are three major ones.

1. Productivity gains from technology

With new technology comes higher productivity and lower costs, especially labour-related ones.  

Look at the Digital Price Index compared to the Consumer Price Index. 

Technology these days is more accessible, less expensive and developing quickly. Drones, automated trucking, completely robotic automated factories. These massive investments in hardware and software lead to lower costs and prices.  

2. An aging population

Demographic profiles are turning increasingly geriatric around the world. Overall, people are living longer and have fewer children on average. So the economy has proportionately more older people than before. 

Later in life, people tend to spend less on average, which is deflationary. 

3. The government debt

Global government debt has exploded in the past 15 years. Governments increasingly need more money to service their social security and old age programs. And They have also had to stimulate the economy after the great financial crisis and the recent pandemic.

However, the government spends more money on servicing the debt and has less money to spend on its future development, reducing economic opportunities. So paying down Higher debt levels is deflationary.

Those are the long-term structural deflationary forces. And there are many short disinflation forces present as well.

  • A global slowdown which decreases the demand for goods, oil and commodities.
  • Recessionary pressures, hurting individual and corporate spending. 
  • Governments cutting back on their pandemic stimulus programs. 
  • People returning to the workforce.
  • And, supply chains starting to ease globally.

As you can see, the inflation conundrum is complex, with many factors at play. 

The Key Takeaway

Short-term disinflationary forces are essentially the unwinding of the short-term inflationary forces, which we’ve witnessed in recent weeks. These forces are expected to bring us to a 4%-type inflationary environment. However, the 2% inflation that we have grown accustomed to will be difficult to realize, at least in the short term. 

In the second video of this two-part series, we discuss how TWM Group invests, specifically the selection process in the equity segment of our portfolios. 

On behalf of TWM Group, thank you for watching and see you next time.

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