In this white paper series, we examine whether inflation is likely to stay at low levels over the next decade.
We also examine how future inflation and overall economic growth rates will impact the attractiveness of the returns Hyperion’s global equity strategy is likely to produce in the long run. The main topics covered in this series are addressed in five interrelated papers:
Part 1 – Why the recent increase in inflation and growth is temporary;
Part 2 – Why the rotation to lower quality value stocks will not be sustained;
Part 3 – The relationship between growth, inflation, interest rates and valuations;
Part 4 – Why high-quality businesses can handle high inflation better than most other investments; and
Part 5 – What if our views on inflation turn out to be wrong?
Part 1 – Why the recent increase in inflation and growth is temporary
We believe higher inflation will be transitory in nature and inflation will remain low in the long term.
There are several reasons that suggest the recent increase in inflation (and economic growth rates) will be short-lived and that these inflationary influences will fade over the next twelve months. Furthermore, once
inflation returns to lower levels (likely in 2022), there are several key structural factors that should result in inflation (and economic growth rates) remaining at low levels over longer time periods.
The recent increase in inflation (and associated strong economic growth) has been driven by several transitory factors, including:
1) The “base effect” from depressed commodity and product-related pricing and negative demand
growth during the early stages of the COVID-19 crisis;
2) The “broken window fallacy”;
3) Distortions in consumer spending patterns, during the initial COVID-19 lockdowns, leading to
unsustainable increases in demand for durable and non-durable goods;
4) Increased government spending on transfer payments boosting short-term consumer expenditures;
5) Unsustainably strong credit growth in China; and
6) Increased short-term demand and related price increases for transport and travel-related services and
products as economies recover from the COVID-19 crisis.
The “base effect”
There has been a large increase in commodity prices over the past twelve months as shown in Figure 1.
Part of the year-over-year increase in commodity prices has been influenced by a “base effect.” That is, twelve months ago commodity prices were very depressed because of the initial impact of the COVID-19 crisis.
Figure 1: Producer Price Index for commodities in the U.S. (12-month percent change)