Inflation can be good for governments, reducing the real value of government debt, but it reduces living standards for those whose incomes are not protected from rises in the rate of inflation.
Keynes called it “Euthanasia of the rentier”, and savers should be under no illusions as the long-term effect of inflation on their financial health, according to John Chatfeild-Roberts (pictured), chief investment officer and head of the Jupiter independent funds team at Jupiter Asset Management.
“In my view, the Consumer Price Index (which is used as an inflationary indicator) under-records the actual inflation experienced by many groups of people, particularly those in retirement,” says Chatfeild-Roberts. “So having exposure to investments that offer some protection against higher prices looks like a sensible precaution. Large multi-national businesses with strong balance sheets are not as cheap as they were but remain resilient in the face of low global growth and their ability to grow dividends through the economic cycle makes them an attractive option for those seeking long-term income and inflation protection.”
Commenting on prospects for markets in the year ahead, Chatfeild-Roberts says: “2012 was a much better year for financial markets than one might have expected given where we started.
“Thanks for this can mainly be directed to European Central Bank ‘ECB’ president Mario Draghi who, in the face of rising government bond yields in Italy and Spain during July, stated that he would ‘do whatever it takes’ to protect the Eurozone from collapse. Bond and equity markets have rallied since this point, helped also by signs of recovery in the US, which remains the engine of world growth.
“It is entirely possible that the current rally will be sustained assuming the ECB continues to support weaker economies and the US recovery carries on. However in reality, not much has changed from a year ago and markets are still facing several long term challenges. The key issue remains Europe. The single currency will only work if Germany is prepared to pay for it – for a very long time. But we don’t underestimate the desire of European politicians to keep the ‘European project’ intact, at almost any price.”
Government spending in the West remains too high, limiting the ability of governments to reduce their debts. For instance, the UK’s National Health Service will cost the UK taxpayer GBP145bn in 2014, but the economy cannot grow fast enough to generate the amount of tax required to pay for it. Public sector pensions are even more costly. In John’s opinion, eventually something will have to give. Furthermore, there is still too much capacity in the system. The Spanish coastline, for example, is reported to have 1.6 million empty properties on it. Until these structural issues are tackled, economic growth will suffer and the paying down of debts will continue.
Chatfeild-Roberts says: “There are also problems with the ‘solutions’ being enacted by central banks. Low interest rates are leaving savers (who outnumber borrowers eight to one) making a loss after inflation on cash deposits, and weak companies which should have gone to the wall are dramatically slowing the normal sharp economic recovery that follows a recession. Furthermore, while printing money through quantitative easing may support financial markets in the short term, it is potentially storing up an inflation problem for the future.
“Despite the problems faced by Europe’s economies, the euro has recovered from its lows (albeit still below the level of a year ago) and this together with the support provided by the ECB has encouraged us to increase exposure to quality companies in this region at the margin. We also continue to favour the US, with our focus once again on larger multi-nationals.
“Interestingly, deflation has been the problem in Japan and so inflation is the key catalyst to unlock the value inherent in Japanese shares. Japanese shares have had a bounce, post their election, and should improve further in 2013 if the new Abe administration makes actual progress towards achieving its inflationary target.”
He believes that fixed interest investments such as government and corporate bonds should be handled carefully. Bonds issued by Western governments such as the US and UK are still in demand despite historically low yields but could come under pressure in an inflationary environment where interest rates start to rise.
He concludes: “Opportunities remain in carefully selected corporate bonds but again, rising interest rates would create a headwind for them.”
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