Amid a new era of inflation, what can you do?

The times are a-changing

Since singer and songwriter Bob Dylan crafted the legendary line “The times they are a-changing” in the early 1960s, a lot has shifted in our world. Even these last few years alone have been massively transformative: the world has navigated a global pandemic, war has returned to continental Europe and inflation’s hit the highest levels in four decades.

The birth of the internet has brought a lot of this change and the financial sector has moved increasingly online. Not only can you bank remotely and shift your portfolio with some clicks on your mobile, market characteristics such as transaction speed have also changed. Consider, for example, high-frequency algorithmic-trading which utilizes financial data and electronic trading tools at high speed and high frequency. Social trading has also brought about a shift in investing dynamics – it makes it possible for individual investors to observe, and therefore emulate, the moves of other investors and experts online. And, of course, the ability to connect virtually, provides potential unity of voice and therefore power for retail investors.

In addition to the changes within the financial sector, prompted by technological innovation and digitalization, the societies we live in tend to be far more interconnected and past-paced. This means that a change in one area of the world can quickly impact something seemingly unrelated and far away. Clearly, current times are very different to the ones Dylan was singing about. Yet, seasoned investors know that a bedfellow of change is opportunity. The pandemic, war in Ukraine and looming energy crisis have brought, and continue to bring, hardship and tragedy – this is not being debated. What is up for debate is how we respond.

What’s changed?

It’s clear that we’ve moved beyond the post-pandemic phase of inflation that occurred when lockdowns were lifted and was considered transitory at the time. Those days are long gone. The economic reality has taken an abrupt turn: Inflation has hit the highest levels in four decades and, if the value of financial investments is to be maintained or increased, an adjustment is most likely needed.

On a macro level, the inflationary environment has forced major central banks to take aggressive steps to normalize monetary policy. Their actions may appear even bolder and starker than in the past, given they take place on the back of an unprecedented phase of zero interest rates and extensive bond-buying programs, which followed the 2008 global financial crisis.

It remains to be seen whether central banks can keep inflation in check without stalling the economy – or whether governments will even play as a team. For example, the Bank of England was thrust into crisis mode recently after the UK’s new prime minister, Liz Truss, proposed new fiscal policies, including unfunded tax cuts and spending – which is unlikely to prevent a recession or reduce inflation, but increases debt during times of increasing interest rates. Truss’s proposal triggered a loss of trust in the new government’s fiscal policies and a widespread sell-off that sent markets tumbling. The Bank of England had to intervene in the markets, by buying up further bonds, to prevent a financial crisis. The government eventually reacted to the market criticism and backpedaled on top-earner tax cut. That further highlighted a disorganized government action.

General uncertainty has stoked widespread fears of a recession. Indeed, in order to dodge a high certainty of pushing the economy into a recession, central banks would need to hold back on rate increases to a certain extent. But that could further feed inflation.

The investing environment has also gotten a lot more complex, and we have higher inflation levels to thank for that. Higher interest rate volatility often accompanies rising inflation, adding uncertainty to the economy and can make people less inclined to take risks on capital markets, such as buying stocks or bonds, as they may perform more unpredictably.

Where to from here?

Investors are well advised to take these developments into account when thinking about how to construct their portfolios to spread the risk across a mix of holdings. Above all, it’s been shown that when it comes to challenging conditions, sitting on the sidelines can bring risks in and of itself. As we’ve mentioned previously, savers are often those who suffer the most when inflation hits, as higher prices lower the real value of their savings. 

Given its far from the first time that markets have been challenging, what can be learnt from the past? When prices rise and consumers tighten their purse strings, it’s worth looking at companies that have high pricing power in their respective sectors. That means that they are able to raise prices quickly to protect their margins without hurting their sales volumes. 

Companies with strong brands or those active in defensive sectors, such as the consumer, food and pharmaceutical sectors, also tend to fare better. Defensive stocks are those that tend to maintain stable earnings, even when the economy takes a turn for the worse. That’s in part because consumers continue to consume items they need in their daily lives, such as health-related products and food. And those sectors tend to have well-known brands, which consumers tend to stick to when prices rise across the board. 

But as financial markets always price the future, investors should also adapt and have a view on whether inflation will trend even higher or abate over the next months and quarters. Financial market prices will reflect the changes to the current situation. Hence, we could find ourselves in a situation where portfolios do not benefit from more commodities or commodity stocks but rather the opposite. Views and portfolios will need to be updated continuously. 

Solutions for a new era

As the staying power of a good brand illustrates, people tend to turn to what they know and trust during turbulent times. As the world shifts, the problems and challenges faced by investors shift, yet so to do the ways that they expect and demand solutions. It’s important for financial services companies to accompany clients on this journey and, at Vontobel, we focus on using technology to scale our mission of empowering investors to build better futures. This stays true to our principle of mastering what we do – and only doing what we master.

Studies show that the demand for digital wealth management solutions will increase in coming years – driven by the growing range of offerings, as well as by the entry into this segment of major market participants with large client bases. This has encompassed broad digital product offerings, including options for portfolio customization.

Forty years ago, when inflation levels last matched those of today, our current access to, reliance on and appetite for digital channels was unthinkable for most. Bringing things back to 1960s folk music, could Dylan have imagined the transformation online streaming services have brough to the music industry? When it comes to financial services, digitalization is changing the way firms interact with investors. New wealthy clients, for example, want round-the-clock access to investment advice and seek to balance a desire to invest themselves with the high level of importance they assign to investment expertise from an established firm. Similarly, the financial challenges being tackled today have evolved to suit the times. So, if you find yourself facing inflation this time round, consider looking at what new tools and solutions are available to you when it comes to wealth preservation via diversification – the answer might be closer to your fingertips than you originally thought.

Our German readers are welcome to see more details on investing in times of higher inflation here: https://derinet.vontobel.com/CH/DE/blog/Artikel/investieren-in-zeiten-erhoehter-inflation