Inflation

Can the share and property market boom continue? We’ve certainly seen the Sunshine Coast Property market boom – together with the ASX200 hitting record levels. Inflation would appear to be the greatest threat to the ‘Goldilocks’ scenario that financial markets seem to have priced in whereby inflation, according to the Federal Reserve, after record money-printing and stimulus, and rebounding economic growth after Covid, will be “transitory” in nature.

“Treasury Secretary Janet Yellen said U.S. inflation risks remain subdued as the Biden administration pumps $1.9 trillion in pandemic relief into the economy and a return to full employment comes into view. ‘Is there a risk of inflation? I think there’s a small risk and I think it’s manageable,’ Yellen said.

Bloomberg, Yellen says US inflation risk remains small, 14th March 2021

However, before you trust the Federal Reserve entirely bear in mind the Fed can be spectacularly wrong:

“…we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”

US Federal Reserve Chair (Ben Bernanke), May 2007

“The Federal Reserve is not currently forecasting a recession.”

US Federal Reserve Chair (Ben Bernanke), January 2008

“The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”

US Federal Reserve Chair (Ben Bernanke), June 2008

Hence, if inflation is indeed the genie that is let out of the bottle and is subsequently not transitory and is indeed persistent there’s only one way to control inflation and that’s rising interest rates. In a highly indebted world even a modest rise in interest rates from record historic lows could have devastating consequences, particularly when share-markets are trading on historically high valuations. For this reason I think most clients should a) be wary of US shares in particular b) be as diversified as possible c) avoid exposure to long duration bonds d) have exposure to alternative asset classes and share-markets that are trading at more modest valuations.