Almost all of us, investors or not, would be acutely aware that inflation remains a significant economic problem in Australia, as it is in many parts of the world. If you weren't reminded of this fact every time you fill up your car, or do the weekly grocery shop, you would be when it comes time to pay the rent or the mortgage.
Inflationary pressures affect daily life. But they also affect how we invest. All investments are vulnerable to the corrosive effects of inflation. Investment properties become more expensive as interest rates rise, which means upward pressure on rents. Companies face rising input costs, which they either have to weather or pass onto their customers. Navigating this proverbial minefield as an investor is no easy task.
Unfortunately, it might be something we may have to get used to, though. This week, Commonwealth Bank of Australia (ASX: CBA)'s chief economist, Luke Yeaman, argued the following in a client note:
…the risks to inflation are mounting, and they sit to the upside. As a result, the November meeting remains 'live'. Even if trimmed mean inflation prints at 1.0% in Q3, the RBA may still want to take out some pre-emptive insurance. At a minimum, the RBA will respond aggressively to any new upside surprises, or any signs that the expected slowdown in growth and resultant easing of inflation pressures is not occurring.
More broadly, the structural forces outlined above have materially increased the risk that inflation will be more persistent than forecast and that several more interest rate hikes will be needed over the next 6 – 12 months. Either way, rates will be structurally higher over coming years. Under any near-term scenario, markets are increasingly coming to terms with the fact that we are now in a higher inflation, higher interest rate environment. There is evidence of this in global bond markets, with US 10-year yields recently hitting their highest level since 2002.
Not exactly soothing stuff. However, we must invest in the world we are living in, not the one we wish we were. So how does one invest under a 'higher for longer' inflationary environment?
Well, I think there are two principles to stand by as we continue to build out our portfolios.
Investing in a high inflation world
Firstly, I think it's imperative to only invest in ASX shares, in companies, that have significant pricing power. Companies that make for successful investments need to be able to pass on any increased costs to consumers. As a shareholder, you don't want to be left with that bill. It is usually the ASX shares that display evidence of possessing at least one economic moat that are able to do this most effectively.
Think of Coles Group Ltd (ASX: COL) or Woolworths Group Ltd (ASX: WOW). As they remain amongst the cheapest businesses to purchase groceries and household essentials from, customers will usually keep coming through the door, even if prices are on the rise. As such, much as we detest it, they can pass on those higher costs to us relatively seamlessly.
Ditto for a company like Telstra Group Ltd (ASX: TLS), or Transurban Group (ASX: TCL). Telstra arguably offers superior network coverage compared to its competitors, whilst Transurban has the right to toll some of Australia's most vital arterial roads. This means that many customers will have no choice but to swallow any price rises these two shares choose to pass on. If you're a customer of Transurban or Telstra, you might not like that. But if you are a shareholder, that's mana from heaven.
Secondly, we can consider cash-based investments. With interest rates so high, we are at a rather unique situation that hasn't been seen for decades. It is now possible to obtain a risk-free term deposit or savings account that pays a substantial and real return. After the latest interest rate hike, it is now possible to get a term deposit that yields as much as 5.5% – well above the current rate of inflation.
Sure, you won't get franking credits or the possibility of capital growth. But you won't get any risk or volatility either. In the current environment, I don't see anything wrong with allocating at least a portion of one's portfolio to these cash assets while rates remain so elevated.
The post Higher for longer: How to invest in a high-inflation Australia appeared first on The Motley Fool Australia.
Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Transurban Group. The Motley Fool Australia has positions in and has recommended Telstra Group and Transurban Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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