Lower our expectations as inflation rises

Over the last couple of weeks we have seen the battle between the performance of equities and the rising inflation rates. As a general rule, rising inflation rates are negative for equities because interest rates go up. Interest rates in the USA will have to normalize after they have been kept at historically low levels during the Covid pandemic to bolster economic growth. Now that we are seeing an increase in the price of most commodities, including oil; as well as a sharp increase in the prices of USA properties; the Federal Reserve will have to start rethinking their interest rate policy. Even in South Africa we have seen the inflation rate creeping up and it is very likely that the next move in our interest rates will be up.

As an investor in equities, especially in the USA, we have seen the interest rate uncertainty causing volatility in the equity markets. We have to remember that investors make decisions based on their expectations of the future. So if they expect interest rates to move up over the next eighteen months, they will start taking profits on their portfolios now. The problem we currently have to deal with as investors in shares is the fact that although interest rates are low and liquidity levels are high due to all the stimulus packages in the USA, Covid-19 has caused the normal spending patterns of consumers to change. The official Inflation in the USA is still muted and the Fed has indicated that they see the current uptick in inflation to be transitory. They are also prepared to tolerate a higher level of inflation due to the unusual circumstances.

So is this a time to buy more shares? As we have mentioned in a previous blog, it might be a situation where shares go up more than they come down eventually. For a longer-term investor, sitting on the sidelines might mean that they have to eventually pay more for the shares they want, even after the much anticipated “correction”. What we can expect, though, is that the stellar return on equities over the last five years in the USA will not repeat itself as interest rates are pushed higher and excess liquidity is reduced. It might be prudent to lower the overall exposure to shares in longer-term equity portfolios and hold more cash, but definitely not to go too far underweight.

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