3 minInflation: a risk for your investments?
Will the recent inflationary pressure force investors to accept a higher risk of volatility?<br> What impact does inflation have on their purchasing power?
Sustained economic growth
After a deep and synchronised recession in the first half of 2020 in the wake of the shutdown of many economies, the strength of the recovery in economic activity has surprised many analysts.
As we enter the new year, investors are wondering what position to take. The ongoing health crisis, high valuation levels in absolute terms, and the emergence of inflationary pressures are fuelling the uncertainty that makes this decision especially difficult.
Inflation: a key concern for investors
Mounting inflation is one of the main concerns for investors. Inflation rates in the US and the eurozone are currently at their highest levels since the early 1990s.
However, the central banks continue to view the sharp price increases as ‘temporary’ since the current surge in inflation has more to do with supply shortages than excess demand.
Inflation expectations, reflected in the bond markets, continue to point to normalisation in the medium term, which remains the most likely scenario at present. Wage cost developments will nevertheless be a key variable, to be monitored closely in the coming months.
Currency depreciation and loss of purchasing power
The authorities’ repeated interventions since the financial crisis have boosted the financial markets on the one hand and economic momentum on the other, at the cost of depreciating purchasing power. This situation could become even more problematic if the rise in inflation proves to be permanent.
In a normal environment, investors with savings can get an above-inflation return on cash. As a result of the ultra-accommodative monetary policies implemented by the central banks, the return on cash no longer provides protection against the effects of inflation. This situation is particularly acute for investors in Europe, where interest rates have passed into negative territory.
For example, €100 would halve in value in 40 years if the inflation rate were 2%. More precisely, its value would fall to €45.29 whereas inflation of 3% would see its value fall to €30.65.
Implications for investors
As cash and quality euro-denominated bond investments have become less and less attractive in the current environment, part of the solution will have to come from equities.
This means that investors will be forced to make the difficult choice of either accepting a higher risk of volatility, i.e. accepting greater fluctuations in the value of their portfolio (upwards and downwards), or accepting a loss of purchasing power.
However, as certain segments of the equity markets are at extremely high valuation levels, it will be necessary to take an active approach to investing and focus on quality companies to limit the risk of permanent capital loss. It will also be essential to strive to skilfully diversify the portfolio.
In conclusion, in 2022, more than ever, investors will have to master the concept of risk-taking in a calculated manner by combining prudence, rigour and discipline in the management of their assets.
To find out more about how to invest in this inflationary environment, contact a private banker.
