Protect your portfolio from threat of rising prices

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Until the numbers get big, inflation usually hovers below the radar. When it soared to 25 per cent in 1975, it dominated conversation in homes and Parliament. 

Recently, there has been more chat about the rising cost of living among economists, and some analysts are describing the short-term risk of higher inflation as ‘scary’. 

The Consumer Price Index stood at 0.7 per cent in March and is expected to rise sharply towards the Bank of England target of 2 per cent in the coming months, due to temporary factors, mainly energy prices. 

It is then expected to hover slightly below that level in two and three years time. So there seems to be no reason for a imminent inflation panic. 

After all, rising prices can be seen as evidence of economic bounce-back, something that Bank governor Andrew Bailey predicted this week. 

But could complacency be damaging to your portfolio? 

Over time, inflation gnaws away at incomes, reducing spending power. This is something it’s been easy to forget, amid the low inflation or even deflationary conditions of recent years, produced by the spread of technology and cheaper goods from China. 

The falls in technology shares this week, provoked by apprehension that inflation will usher in higher interest rates, are a compelling reason to focus on the risks. 

Tech stocks are vulnerable to alarm over interest hikes. If the rates on cash deposits improve, the future earnings of Amazon and others in the ‘growth’ category can appear less valuable. 

The Berkshire Hathaway guru Warren Buffett is warning that America’s ‘red hot recovery’, fuelled by the stimulus package, may stoke inflation in the US and elsewhere. 

The US Treasury Secretary Janet Yellen is now acknowledging that a modest rate increase may be needed to stop overheating, although US central bank the Federal Reserve says rates will remain unchanged until 2023, even if inflation spikes. The Bank of England is taking much the same stance. 

Despite such assurances from central banks, US investors are putting money into inflation-linked government bonds or TIPS (Treasury Inflation Proofed Securities), having observed the bounce in the price of commodities like coffee, corn, lumber and wheat. 

These are not the only essentials becoming more expensive, as Mikhail Zverev, head of global equities at Aviva Investors points out: ‘The near-term outlook for inflation is alarming as a result of the really rapid economic recovery. Over the past 12 months, oil has risen three-fold, steel is up two-fold and copper is also higher. These input costs will be passed onto customers.’ 

Geo-political issues are also exerting upward pressure on prices. TSMC, the Taiwanese semi-conductor maker, which supplies 84pc of global computer chips for cars and phones, is in the cross-hairs of tensions between the US and China, a nation frequently cited in the debate about inflation. 

‘Deflationary pressures are running out of steam. China is no longer an exporter of deflation because wages are rising, but nowhere else is big enough to replace it at the time being.’ 

Zverev has been repositioning Aviva funds like Global Equity Endurance for the changed climate, and is more sanguine about the medium-term, but senses that labour inflation could become an issue further down the line.

Advice: The US Treasury Secretary Janet Yellen

Advice: The US Treasury Secretary Janet Yellen

Competition, at least in theory, should help keep a lid on prices. Companies that do have the capacity to make their goods and services more expensive include luxury goods names, such as Burberry, Estee Lauder and LVMH, and businesses like Unilever whose divisions include upmarket skincare, and the foods we crave like Marmite. Rightmove, tapping into the national passion for property, is also regarded as a business with strong pricing power, thanks to its dominance. 

Burberry is up 17 per cent this year and LVMH is at a record high. But you may already be a holder if you have a stake in the Fidelity UK Select fund, which owns Burberry, Rightmove and Unilever. Fundsmith backs Estee Lauder and LVMH. 

An upward move in rates could benefit insurance companies such as Legal & General, which earns interest on policyholders’ premiums. Darius McDermott of Fund Calibre argues that non-life insurers should be able to drive up premiums this year, good news for the Polar Capital Global Insurance fund. Banks should prosper if rates rise, but inflation would eat up some of the value of their loans, which is one factor behind the lack of enthusiasm for these shares.

If you suspect that the Wall Street’s reluctance to trust the Fed’s pledges could provoke nerve jangling bouts of market turbulence, you could consider the solidly defensive Ruffer Investment trust with its holdings of TIPS. 

However, it’s worth putting inflation worries into context: the oft-discussed hyperinflation of the 1930s Germany is not set to be replayed. Retreating into cash would be ill-advised, as inflation would nibble away at your savings – and the returns would still be negligible. As McDermott puts it: ‘If inflation is a threat, shares are a good place to be.’ 

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