On the back of surging commodity prices, this week saw miner BHP Billiton overtake Unilever as the UK’s largest listed company by market capitalisation. We also saw the welcome restoration of dividends not only from Billiton but also Glencore, Rio Tinto and Barclays, providing welcome relief for income investors.
It is difficult to escape the inflation debate. As the prospects for global economic recovery become more apparent, it is not just oil and the traditional hard commodities such as copper, iron ore and steel which are seeing price rises, in some cases significantly; to these can be added others such as heating oil, lumber and rubber. Soft commodities too are undergoing a resurgence: wheat, soyabean, sugar, beef, poultry, cotton, palm oil, all on the rise (indeed about the only consumer staples prices not appreciating are milk and rice). Among economies which are currently slack but with recovery potential, many with temporary over-capacity, some companies may be able fully to recover rapidly rising input costs in their own selling prices (exacerbating short-term economic inflationary pressures) while others may have to absorb the costs to a greater or lesser extent, putting pressure on margins and profits. While perhaps not usually as extreme as now, volatility in commodity prices is certainly not unprecedented, and the effects tend to be transitory.
Long-term structural inflation is another matter. Following the inflation peaks seen in the late 1970s, a long-term disinflationary trend (disinflation: prices rising but at a declining rate) dates back to the mid-1980s, extending to more powerful deflationary forces (deflation: nominal prices falling) at work for the past 20 years created by fast-developing disruptive technologies, the effects of globalisation and, more latterly since the Global Financial Crisis, the deflationary effects of central bank interest rate and QE policies flooding the system with cheap liquidity, propping up companies which would otherwise have gone bust. The headline inflation rates in most western economies whose central banks have been working to a mandate target of 2% have been remarkably stable in recent years as big inflationary and deflationary forces more-or-less balance each other out.
However, in response to relatively pedestrian growth rates exacerbated by President Trump’s trade wars, governments have been minded to stoke the economic fires using fiscal stimulus (i.e. spending taxpayers’ money on social, industrial and infrastructure projects), a Keynesian economic approach which used mainly to be the preserve of left-leaning governments but is now common among those more rightward inclined too, including our own. The Covid crisis response, significantly compounded by the climate change debate and meeting the targets laid down in the Paris Climate Accord, has turbocharged the effect. “Digitisation is deflationary; decarbonisation is inflationary”; a sweeping generalisation but intuitively correct. The digital economy is with us and established; decarbonising the economy, William Hague’s “industrial revolution by coercion”, has barely begun.
But political ideology plays a significant hand too. Nowhere is this more evident than in the United States as the new Biden administration gets into its stride. Chalk-and-cheese in comparison with its Republican/Trumpian predecessor, it is also likely to be far more radical than its Obama-led Democrat forerunner. Now with a clean sweep across the White House, The House and the Senate those pushing a ‘progressive’ agenda are in the majority among Democrats and prepared to force the pace. Evident in the ‘go big’ phraseology of President Biden and his new Treasury Secretary Janet Yellen (former Federal Reserve Chair), not only do they believe ideologically in the pursuit of the Keynesian agenda, they are absolutely determined that this Democrat administration will not be accused of being little more than an onlooker in response to Covid, as the Obama government was accused in the aftermath of the GFC. Biden’s manifesto listed 39 Bold Ideas, by far the majority of which were about equality and opportunity; many Democrats are prepared to push the political and fiscal boundaries, not only unwinding Trump’s tax reform but going much further being far more aggressive than Obama with corporation and personal taxes, seeking wealth taxes and significantly higher rates of capital gains tax (CGT); they will push to double the minimum wage to $15/hr and drive deeper unionisation in the work-place and legitimise collective wage bargaining and strike action. Lastly, as the US approach to climate change spins 180 degrees, a vocal and highly media-savvy group in Congress, among Democrats already pushing on an open door, is driving the agenda for even more rapid and radical policy change and, as one commentator observed, “there is not a dollar they won’t spend to decarbonise the economy”. Outside the administration the unapologetic socialist Bernie Sanders, new chair of the highly influential Senate Budget Committee, has no pretensions to shyness about ‘progressive’ spending on climate change, universal healthcare provision, equality, jobs and social security, looking to fund part of it with big cuts in the military budget. The US political boat is veering left, it is just a question of how far. The land of small business and entrepreneurialism, America has resisted it in the past, but does it now ‘do’ socialism? It is about to find out!
New inflation or old deflation? Which will have the upper hand? Investors are watching closely. They are not panicking that run-away inflation is an immediate concern. However, without any change in US interest rates (still 0-0.25% and the Fed forecasting no change in the foreseeable future) the 10-Year Treasury bond yield at 1.3% is a full point higher than it was in late March last year with momentum behind it. The US 10-Year Treasury is the proxy for the global risk-free rate (the anticipated rate of return on a riskless investment maturing in ten years); investors are hedging their bets through bond risk premiums that the combination of the ‘fiscal surge’ and the Fed being entirely accommodating and happy to let the economy run hot (in addition to which Fed Chair Jerome Powell has said that government debt gives him not one minute of lost sleep), if structural inflation has a chance of making a meaningful appearance it’ll happen under this administration.
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.
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