Energy is a huge part of the inflation picture and the current issues aren’t going to be solved overnight. In the West it’s a long-term problem caused by underinvestment in oil, gas and nuclear as well as a drive towards renewables.
The problem has been exacerbated in the short term by unfavourable weather patterns, but that’s part of the point: an increasing reliance on renewables means we have plenty of energy generation but not necessarily at the times of day when people most need it. At the moment, and for many years to come, we do not have the technology or infrastructure in place to effectively store and release that energy. Western governments, unless they do a u-turn on climate policy, will face an energy squeeze for a long time.
So far, so troubling. But the most pressing question to us as equity investors is: “how long do the current price dynamics have to last before it creates a serious economic problem?”. If you look back in history then very high energy prices are often followed by some sort of financial catastrophe – oil and gas prices are already well within that range and climbing. Apart from the decision about whether to shift portfolios in a more defensive direction or not, there are stock-level considerations around costs to energy intensive businesses over the next twelve months as forward energy contracts roll off.
The other aspect driving inflation is supply chain disruption. Transport logistics has been a hot topic in the UK for several weeks, but it is by no means a problem confined to our shores. It is essentially a Covid issue (or has been dramatically accelerated by it) but even if Covid magically disappeared tomorrow it wouldn’t solve the world’s logistics challenges. These are baked-in issues now, with labour market dislocation that can only be solved by long-term repositioning of the workforce.
There are some companies that can pass on their increased costs just fine, including industry leaders with a dominant market share. Others, such as pubs and restaurants, could pass it on but don’t want to for reasons of competition. Lastly, there are sectors like food producers and online retailers that seem unable to pass on higher costs to the consumer.
Whether or not inflation itself is transitory or embedded, the effects that this inflation spike (if it’s just a spike) are having are, in my view, certainly not transitory themselves. As investors in businesses and portfolio constructors that’s something we’re grappling with, and as active investors we of course have the ability to change that quite significantly if we decide that’s in the best interests of our clients.
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