Don’t whip out the bell-bottoms just yet

While bell-bottom trousers and the rise of disco were eagerly embraced in the 1970s, higher inflation was not. The Great Inflation lasted from 1965 to 1982 and coincided with four economic recessions, two major shortages in energy supply and the introduction and withdrawal of wage and price controls.

Today, as the economy roars back from the Covid-19 pandemic, fears of higher inflation have resurfaced following a protracted period of ultra-accommodative monetary policy and generous fiscal stimulus to shore up economic activity. Nevertheless, we believe that fears of a ‘70s style inflation episode are overdone.

Although the gap between demand and supply is like the experience of the ‘70s, this time around, demand has overshot. Though supply has turned higher, it has been unable to match the surge in demand related to accumulated household savings.

The level of dispersion in global inflation also remains low, with only a few goods experiencing steep price increases. Supply chain bottlenecks in specific areas of the economy, exacerbated by the so-called bullwhip effect (the Bank for International Settlements explains this as hoarding, which makes already tight supplies worse in key markets) are expected to unwind as demand alleviates on dwindling excess savings and as goods purchases rotate to services. With additional capacity coming onstream, prices are expected to normalise.

Considering the outlook for 2022, Goldman Sachs projects far fewer port closures in the coming quarters, while the International Energy Agency points out that a return to warmer weather in the Northern Hemisphere in the second quarter of 2022 should lower energy demand as supplies build. While stimulus cheques and equity market gains have reduced the incentive for people to get a job, this may unwind. Previously ill workers are likely to re-enter the workforce, while restrictions on legal immigration may ease, alleviating the labour shortage and capping wage gains.

Notwithstanding larger government balance sheets, the International Monetary Fund has further shown that monetary expansions are not necessarily inflationary if the starting point of inflation is low and if central banks operate under strong independence. In recent history, central bank independence has guided inflation expectations lower in both advanced and emerging economies, such that, even against today’s inflation scare, longer-dated expectations of inflation remain reasonably well-anchored across the globe. As such, even though we expect a lift-off in rates by the Federal Reserve in the United States in the second half of 2022, the expected cumulative response is likely unchanged from prior to the rise in inflation fears, given the shift to a new policy framework, which is more tolerant of inflation.

South Africa follows a different path

Although inflation fears have climbed in a number of economies worldwide, South Africa has followed an atypical path given continued slack in the economy and depressed demand. Muted job expectations are likely to hold back consumption in the coming quarters. A necessary jump in sentiment to drive infrastructure has remained largely absent in the context of slow progress on structural reforms and persistent energy supply constraints.

Although the fiscal stance improved markedly on a rebasing exercise (which left the economy 11% larger) and a commodity price boom, both are seen as once-offs, complicating the financing needs for structural expenditure demands. The required focus on a narrower fiscal deficit over time and a stabilisation in the country’s debt ratio to keep rating agencies at bay suggests reduced scope for the government to support the economy. As such, a weaker growth environment and little inflation pressure support a modest tightening in local interest rates in the coming years.

Investing is personal

Inflation and other economic factors all have an impact on the outlook for different asset classes over the longer term, but advisers should help clients not to make investment decisions focused on short-term market and economic events.

With our outcome-based investing approach, we construct investment portfolios based on clients’ personal circumstances. This forms a solid foundation for helping them achieve their investment goals.

Although we don’t expect inflation rates akin to the 1970s to make a comeback, who knows if disco dancing and bell-bottoms will return? But we believe that just like your fashion choices, investing is personal.

Momentum Investments is part of Momentum Metropolitan Life Limited, an authorised financial services and registered credit provider (FSP 6406).