Many people are talking about inflation as if it’s the new bogeyman to spook investment markets, but take a closer look and there are also opportunities.
As Baker Young analyst Toby Grimm told the Australian newspaper recently, his firm has researched the impact of higher interest rates on stock markets over 30 years and found they benefitted from higher prices in terms of revenues and profits.
“It’s a little counterintuitive, but markets do quite well if interest rates rise,” Grimm said.
Firstly, in amongst all the scary talk, the point needs to be made that Australian inflation is nowhere near as strong as it is overseas.
While inflation has hit 6% or so in the US, Australia’s recent CPI was at 3.1% and trimmed mean inflation – which is important because this is the data the Reserve Bank uses in its interest rate forecasting – is at only 2.1%.
With this in mind, RBA Governor Philip Lowe is sticking with his view that this trimmed mean inflation won’t get to 2.5% until late 2023, with the next rate rise still a way off in 2024.
Regardless of this, commercial interest rates are on the rise, as you’d know if you checked fixed term mortgage rates recently but this points to one of the investment opportunities in a higher interest rate environment, and that is the banks.
If interest rates rise, banks are likely to improve their margins on lending. This will boost their revenues and, you would assume, bank share prices.
With the size of mortgages growing ever larger due to the current boom, higher interest rates on higher mortgages will hurt borrowers but will see more money flow to the banks.
The average home loan in Australia is at around $570,000 and at $460,000 for first home owners. This is roughly double the size of 10 years ago, so imagine the positive impact on bank revenues if housing interest rates go up by even 1%.
What you pay out in extra mortgage payments might come back to you in capital gains on bank shares and dividends, if you hold bank shares or ETF funds which track them.
Just as an aside, if you are cashed up and waiting to buy property right now, there’s an argument that you might wait, as higher rates could see the boom stall and prices come off. More affordable housing, wouldn’t that be an opportunity!
Back on the stockmarket, insurance companies also stand to benefit from rising interest rates because they hold large investment portfolios, while energy and commodity producers such as Santos and BHP should be on the right side of rising inflation as prices for what they produce also increase.
Another sector which can benefit from higher rates and inflation is infrastructure, particularly in so-called “user pays” assets such as toll roads, airports and ports which some analysts say are in a ‘perfect storm’ where they can benefit from rebounding economic activity with an inflation hedge.
This is the view of Sarah Shaw, global portfolio manager and chief investment officer at boutique manager 4D Infrastructure, who says that infrastructure is “still the place to be” and that her funds are overweight in “user pay assets.”
“They have a positive correlation with GDP, and inbuilt tariff inflation measures,” Shaw told a webinar this week hosted by Bennelong Funds Management.
“These protection measures kick in and positively impact earnings.”
Meanwhile the Christmas spending spree – Australian shoppers are expected to splurge $58.9 billion – is likely to do wonders for companies like JB Hi-Fi.
“There’s going to be an element of revenge spending heading into Christmas, and travel will be constrained for the next few months because flights are expensive and it’s complicated to go overseas, so I think a lot of that money will be spent on shopping,” says head of Australian equities at Tamim Asset Management, Ron Shamgar.
So, instead of running a mile from the inflation bogeyman, perhaps it’s an idea to invite him in and have a chat.
He might have some investment ideas which you can turn to your advantage as the economy moves into the next phase of the cycle.