The Bank of England may have held fire on increasing interest rates at the November meeting of the Monetary Policy Committee. However, it is under no illusion that inflation has peaked, with expectations of a 5% reading in the spring.
Since the start of the year, there have been conflicting views on whether higher inflation presents a transitory blip, or whether consumers and investors should buckle their belts in preparation for a longer-term soar in prices. The latest reading, for September but released in mid-October, put CPI at 3.1%, down slightly from 3.2 % in August.
The first school of thought, still shared by the vast majority of Bank of England policymakers, is that the five-month breach of its 2% inflation target (which was first recorded in May’s CPI reading) is essentially unsurprising given the events of the last 18 months. In fact, the consensus view among this party is that inflation will rise even further, hitting 5% in the spring of 2022 before gradually retreating back to ’normal’ levels .
Why? Following over a year of lockdowns and restrictions, it is hardly shocking prices are rising as consumers get back to ‘business as usual’ and spend money they were unable to last year. Throw in supply chain issues and a surge in oil prices, and you have the perfect trifecta for a temporary jump in inflation.
The other school of thought has taken a more bearish attitude.
Their main concern is that, given the sheer level of recent disruption to the UK economy, we could quickly hit levels of hyperinflation not seen since the 1970s.
The BoE’s ex-chief economist, Andy Haldane, who retired in September, voiced his concerns earlier this year. Admittedly, he did not go so far as to suggest we could shortly find ourselves paying for a loaf of bread with a wheelbarrow full of cash. However, he has warned it is more and more likely that the UK’s rate of price rises follows that of the US, which recently reached 5.4% year-on-year.
As it stands, the market has been surprised by the Bank’s decision to stick on 0.1% interest rates. Investors are now predicting the first rate rise to come after the MPC’s December meeting.
The importance of pricing power
Whichever way you look at it, these eventualities will have consequences for businesses. Inflation always does—it’s an inescapable part of the economic phenomenon.
That’s why an absolutely essential factor for us when picking any stock is how resistant it is to the rising tide of prices. After all, the more “inflation proof” a company is, the more likely it is to thrive regardless of the circumstances.
For us, a key indicator of a stock’s resilience here is its degree of pricing power.
Indeed, the stronger a company’s branding and intellectual property, the more loyal customers are to its products. And the more flexibility a company has to increase its prices in response to inflation without losing customers, the more likely it is to be able to weather any inflation storm and maintain—or even increase—its margins and profitability.
One classic example is Guinness currently owned by British beverage behemoth Diageo.
From just 1.25p in April 1900, a pint of the ‘black stuff' today will set you back, on average, around £7.20. That’s a 57,500% increase in price!
Since the Guinness brand is so strong, the price has consistently been able to outpace inflation throughout history.
On the flipside, televisions are an example of a product that has not been so resilient to inflation over the years. Flat-screen TVs could easily have fetched a price tag north of £10,000 back when they were first introduced by Fujitsu in the mid-nineties. Fast forward to today, and a 55”, top-of-the-range, ultra-HD Samsung TV would set you back only around £480.
The reasons for this are twofold. First, the TV supply chain has become much more efficient, meaning companies can manufacture and sell TVs at a vastly lower price. And second, TVs are essentially exactly the same once you take away the branding, with far fewer differentiating features than equivalents like smartphones and tablets.
Essentially, electronics brands have had no other choice than to lower their prices—regardless of inflation.
Positioned for positive returns
We don’t yet know whether inflation will continue to soar or return to normality over the next year and beyond. In fact, that sort of crystal ball gazing is often a very thankless task.
What we do know is that whatever happens, companies with pricing power will be in the strongest position. This always has been, and always will be, the case.
With this in mind, we believe that—in this world of extreme uncertainty and rising prices—a portfolio of equities with the ability to increase their profitability dependably offers investors the greatest chance of consistently generating positive returns.
The above article has been prepared for investment professionals. Any other readers should note this content does not constitute advice or a solicitation to buy, sell, or hold any investment. We strongly recommend speaking to an investment adviser before taking any action based on the information contained in this article.
Please also note the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.