Inflation and long-term structural changes: a different decade ahead?
A frequently heard criticism of the UK market is that it has little exposure to tech.
While this is true, it does have exposure to many good companies in other areas. Often, these companies have not been strong capital growers over the past ten years. However, with the global macro situation as it is, and with inflation re-emerging, the next ten could look quite different.
Markets had got used to the idea that inflation was a thing of the past. However, what started with rising commodity prices has now spread to supply chain disruption and, crucially, to wage inflation.
Against this backdrop, large caps are more likely to have the market power and balance sheet strength needed to offset the effects of inflation. In addition, the FTSE100 looks more like a value portfolio than the mid-250.
It is worth remembering that equities in general are a hedge on inflation, and a number of our portfolios have good exposure to utilities, which often have explicit index-linking in their business models.
Higher inflation also tends to result in a higher cost of capital and more plentiful nominal growth. Both these factors would put pressure on high value stocks held in momentum-type strategies and favour shorter duration stocks in strategies that emphasise a fundamental approach to valuation.
Within UK equities, there is also the opportunity to invest in a good range of long-term structural themes, such as climate change and digitalisation. Utilities are a play on the energy transition and, ultimately, so are the oil stocks.
Banks and insurance companies have spent the past ten years digitalising their processes, but to pick up again on the mining theme, you can’t digitalise away a tonne of copper! Our brave new connected, digitised, electrified world will be made out of it.
Why we’re excited about our portfolios
While the medium to long-term outlook for UK equities is positive, inevitably there will be near-term volatility.
The removal of the Universal Credit top-up, higher taxes, higher utility bills and general inflation will weigh on the UK consumer over the next year, although a large part of this pressure is likely to be mitigated by wage inflation.
In addition, the UK savings ratio remains elevated. We would expect this to fall back, and this should support consumers’ ability to spend.
But the bottom line is that the improvement in outlook for UK corporate earnings and both the UK and global economies should, in an undervalued market, boost the outlook for UK listed equities. Key beneficiaries will likely include high quality businesses, which form a significant part of our portfolios.
This last point is key. While we are optimistic about the UK market, it is worth reiterating that our portfolios are what excite us the most.
This excitement comes from our positioning in high quality, cash-generative businesses, with strong liquidity, that we think are likely to emerge from the pandemic in an even better competitive position than beforehand.