Monthly Market Outlook

Market participants aren’t pricing in problematic inflation at present. Perhaps they should take a second look.

July 2021 (Click here to download)

‘Lower for longer’ was a term used to describe the post-credit crunch interest rate environment, a period in which interest rates languished near 0%. The promise of rates being lifted as the global economy strengthened never really materialised: rates stayed lower for much longer than originally planned – a decade – and then came Coronavirus.

We’re now seeing a similar story take shape, this time on the subject of inflation. The Central Banks reiterate that accelerating inflation is ‘transitory’ and not a cause for concern, but it’s the Manager’s advice that investors prepare themselves for a different truth entirely: inflation is going to be higher for longer.

But dissecting the Consumer Price Index to see what’s driving inflation is akin to reading tea leaves. It’s better to take a step back and understand the wider picture rather than the minutiae. If we look at the period from 2003 to 2006, you can see that US inflation was regularly above 3%. It hovered between 3% and 4% for a multiyear period: it’s not unprecedented for higher levels of inflation to follow economic downturns (in this case, the bursting of the 2001 tech bubble).

Chart 1: Persistently high inflation rates have followed past recessions

Source: Sanlam Private Wealth, Bloomberg

To understand the shorter-term data, we need to anchor our understanding to the bigger picture. The base case is for structurally higher inflation. This doesn’t mean runaway inflation that can never be tamed, but persistently higher for long enough to eventually change people’s mindsets. In the meantime, markets will ebb and flow as the data washes around.

As for the overall investment scenario, the bull market remains intact. Equities can withstand inflation. While there are short-term risks from elevated valuations, the risk to earnings is actually quite small. Carefully selected companies can grow earnings and take advantage of higher inflation and the business cycle. Meanwhile, the Manager can manage the risk from valuations by making sure the shares it owns aren’t too expensive, and ensuring it is able to increase its exposure to equities if valuations do fall to reflect policy uncertainty. The Federal Reserve’s response to rising CPI is not going to be sufficient to fight inflation; instead, the Fed will likely allow it to remain elevated but attempt to contain it. Company earnings are linked to inflation, so though prices and valuations may temporarily fall in the short term, earnings growth will continue to drive longer-term returns.

“It’s perfectly reasonable to expect inflation to be 3% to 5% for the next five years.”

Philip Smeaton
Chief Investment Officer on the long-term effects of ‘transitory’ inflation


The unusually high year-over-year change in USD money supply from December 2019 to December 2020.

Source: Bloomberg

Investment View: Your bank balance isn’t as healthy as you think

While the financial downturn born of Covid has had myriad negative effects – workers were furloughed from their jobs, and high streets were hit hard – there’s been one surprising and anomalous consequence of this particular recession: with lockdowns eliminating the ability to go out and spend money, many people are finding their bank accounts unexpectedly flush with cash.

Current economic data lays bare an interesting juxtaposition: interest rates are at an all-time low, hovering around 0%, while at the same time, inflation is pushing towards a 10-year high of 3-4%. This means you are unlikely to earn any money from a traditional savings account. And while your money stays static in the bank, the costs of goods and services are steadily increasing, diminishing the value of your cash.

We’ve all had an unusual year complete with limited opportunities to actually spend money, and the lucky among us have seen our bank balances creep higher. This is the time to seek out other options — because keeping excess cash in the bank could very likely lead to your capital eroding.

One of the simplest, most effective ways to put extra cash to work in the market is to open an ISA. These individual savings accounts are tax wrappers, which means they’re protected from taxation. Additionally, it’s a myth that once you put your money in the market, you can’t get it back out. Sanlam’s portfolios, for one, invest in both cash and liquid assets, which means there’s always the option to move your money. Junior ISAs are also available if you’re looking to pass that stash of cash onto a child or grandchild.

So, how much better off will you be transporting your savings from a basic bank account to even the simplest investment vehicle? The answer will be as varied as the customers who open them: it depends on your individual preferences — your risk appetite, whether you’d like to access the cash in the near term or not touch it until retirement, and, of course, how much you’d like to invest. The graph below takes a sample sum of £20,000 and imagines it in two scenarios: firstly, sitting securely in the bank and, secondly, investing in an ISA allocated to the US market.

Chart 2: Growth of £20,000, saving versus investing

Source: Sanlam Private Wealth

It’s fair to say that in today’s economy, an ISA will grow your money while a traditional bank account will witness it erode. Remember too that there is no capital gains tax associated with cashing in an ISA; you won’t pay any tax to take that money back out.

Source: Sanlam Private Wealth.

Sanlam Private Wealth is a trading name of Sanlam Private Investments (UK) Ltd.

The information and opinion contained in this Monthly Commentary should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed are based on information received from a variety of sources which we believe to be reliable but are not guaranteed as to accuracy or completeness by Sanlam. Any expressions of opinion are subject to change without notice.

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