Whoever gets inflation right will hold the key to the winning asset pick.
Everyone talks about bottlenecks, but no one explains why they have occurred, much less “bottlenecks” to say how long they can last.
But you have to get wet, because it is a fundamental question when it comes to predicting what the level of inflation may be in the medium term, which is the mother of all battles when it comes to investing now in the financial markets. Whoever gets inflation right will hold the key to the winning asset pick, which is what defines the result of a portfolio of funds. Much more than the selection of managers.
If inflation is going to remain high for a long time, certain assets will perform better. Some will even greatly benefit from your presence. If we go back to the pre-pandemic situation, others will work just fine. The difference can be abysmal.
I will explain bottlenecks with an example: imagine you have a business that has been closed during the lockdown. Of course, he does not have a warehouse full of products, since he does not know what the demand will be when the reopening takes place. And more when the majority of economists, analysts, tweeters and influencers they tell him that after the pandemic the real crisis will come (forgetting that we have indebted the next generations up to their eyebrows precisely to avoid it and that the central banks have watered the money system as an antidote).
In the case of a small business, it is easy to adapt if you see that people go out to the streets willing to spend and consume. But imagine when this happens in a mining operation in an emerging country -or directly underdeveloped- that has had to close due to Covid. And the vaccines haven’t even arrived yet. A mining operation is not started just like that. And less in those circumstances. The manufacturing rate of a large factory is not doubled, nor are ships chartered that have been stranded for months, etc., etc.
Whoever gets inflation right will have the key to finding the winning asset selection, which is what defines the result of a portfolio of funds
Also, it is a vicious circle. When merchants or large car manufacturers -or computers, or whatever- see that there are supply problems, they get nervous and buy anywhere and at any price. Not just anyone, but are willing to pay much more. They will see later if they pass it on to the client. The fact is that a certain panic is generated at not being able to meet the demand. And so we have the bottleneck and the inflation it generates.
Clarified this, let’s go with the predictions. The first is that just as the law of supply and demand works to increase prices, it also works to balance supply and demand. In a market economy, when someone wants something and is willing to pay for it, the offer ends up arising. Another thing is the price.
When will equilibrium occur? It is impossible to predict. It is necessary to follow the evolution of the prices of the different components and the advanced economic indicators that affect these products. For example, see how the traffic jams are going in the North American, Chinese or European ports. It is about monitoring the situation –and the prices– of the production and distribution chain in each of its links.
Although there will be a break-even point, current energy prices are the result of a structural decision that will take a long time and cost money
This goes for many things, not so much for energy prices. Although there will be a balance point, current energy prices are the result of a structural decision – the energy transition – that will take a long time and cost money.
What seems clear is that even if we solve the bottlenecks, inflation will be much higher than it was before the pandemic. Although the growth generated for the next two years is of somewhat artificial origin, the result of the mix of monetary and economic stimulus, it will be significant growth.
It does not have to imply high inflation, we will see, but wage pressure is more evident every day, which will be added to the cost of the energy transition. In addition, inflation has a lot to do with sociology: once it is inserted into the minds of consumers, it feeds back.
For investors the conclusion is easy: in the coming months the issue of inflation will continue to be the key to the evolution of the markets and we must know how to handle it. You have to know which assets and sectors benefit from each level of inflation. Because in this the nuances are important: little is not the same as a lot or a lot of inflation.
And in all inflationary scenarios – little, a lot or half a pensioner – you have to avoid bonds and medium- and long-term fixed-income funds like the plague. I said it on May 4 from these same pages, and you see. We call that strategy “The Great Rotation”. Now I insist on it, because the rotation has not ended. It’s probably just started.
*** Víctor Alvargonzález is an independent financial advisor and founding partner of Nextep Finance