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Client Update - 1st April 2021

In recent weeks I have written about rising inflation and the effect on bond yields and future interest rates. Conjecture is all good fun, but what recent evidence do we have of a likely final outcome? The nearest parallel to today was probably in 2016 when 10- year Treasury Bond yields rose from 1.3% to 2.5% between July and November that year. This coincided with a year in which technology shares experienced a sharp correction, before embarking upon a sustained rally through the 4th Quarter into 2018 as inflation failed to materialise.

Data on current inflation is a little disjointed, but it does seem to be on the rise for now. The next couple of months will probably see inflation edging up a bit (although even as this is being written the UK figure has come in lower than forecast for February) as most commentators point to higher oil and commodity prices in recent months as being a cause for this expected jump. Counter-intuitively though, a higher oil price can lead to a fall in inflation beyond the immediate timescale as, according to John Authors writing on Bloomberg last week, “higher oil prices act like a tax increase, and tend to dampen consumption.” The impact of multiple lockdowns and the necessary withdrawal of the furlough scheme in time can hardly be seen as inflationary for wages either, and it remains unclear whether there will be a more permanent shift towards flexible hours, part-time working, self-employment, or reduced hours overall, none of which points towards higher wage demand. Let us not overlook the fact that automation has probably taken a step forward due to the pandemic as well and the deflationary effects of technology have probably only been accelerated by the events of 2020. Ah, but what about the stimulus cheques in the US I hear you cry? Fair enough, there is a likelihood that these may be spent more than saved, but as we mentioned last week, if they are spent, this is likely to be short term spending and therefore only a temporary spike to inflation.

What about demographics? Again, it is hard to make the case for inflation in the longer term whether the population is aging. The older generation tends to save more (not inflationary) while the younger generation of under 40s is spending their money on much different “stuff” than people of my generation did – and differently. Much of their spending has moved online and they tend to be cost-conscious.

This short-term inflationary pressure has led us to rejig our portfolio to accommodate more value equities that should do well in this environment, and we have reduced our technology exposure accordingly. Having said this, this may be a short-term position.

Last week, England’s chief medical officer, Chris Whitty, warned that the UK will see another surge in COVID-19 cases at some stage. Simple arithmetic demonstrates why. Government modelling assumes an overall vaccine take up of 79%. Coupled with effectiveness of 80% to 95%, depending on vaccine and the dosage, this could potentially leave as much as a third of the adult population at risk. It seems optimistic to assume that rising case rates could be confined entirely to the healthy and young. New variants are another risk. The vaccination programme has turned the tide, but it is likely we will have to live with the virus for some time yet and with these waxing and waning infection rates, stay at home stocks will once again return to prominence and surely it is better to have an overweight to future technologies, than to have too much exposure to a world without focus on the environment, social issues and strong governance, that is being slowly left behind.

I wish you all a lovely Easter break, and I will write again next week.

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