Inflation Now: What are the Drivers and is it Transitory or Long Term?

On Thursday, July 8, VanEck held its second, virtual VanEck & Friends Afternoon. As with our Gold Insights afternoon, the idea behind it was to create a combination of timely insights, actionable ideas and solutions to challenges we have heard from investors. This time it was the topic of inflation, an issue currently high on many people’s agendas. We believe the event was a success and we certainly enjoyed hosting it. By our reckoning, those attending represented over $5 trillion in assets under management/advisement.

To complement what investors already knew, and for them to benefit from the sophistication and knowledge of institutional professionals, we wanted, once again, to bring together, in one place and in one conversation, the current perspectives on inflation of leading investors, allocators and investment consultants.

The afternoon kicked off with an introductory presentation by Shawn Reynolds, Portfolio Manager of both VanEck’s Global Resources Strategy and its newly-launched Environmental Sustainability Strategy, and Charlie Cameron, Deputy Portfolio Manager of VanEck’s Global Resources Strategy, on the VanEck Inflation Outlook (see Navigating the Markets: Inflation and the Risks to Goldilocks and Play the Inflation Trade). This was followed by an update and remarks from Roland Morris, the firm’s Chief Commodities Strategist.

The VanEck team started their short segment by focusing sharply on what are probably the two most pressing questions being asked around inflation now: What’s driving it? Is it transitory or not? They followed this up by addressing the two important themes in global resources space: current supply/demand challenges (and responses) and energy transition. When it came to outlook, and the influences on potential inflation inside the commodity complex, in the short term, macro factors were seen to dominate; in the medium term, it was supply/demand dynamic; and, in the long term and with a more sustained impact, it was energy transition.

These were followed by contributions from the “& Friends”. Tom Crescioli, Senior Portfolio Manager, Lockheed Martin, with a look at Forces of Secular Inflation was followed Tom Fletcher, Managing Director of Russell Investments’ Overlay Services business and Celia Dallas, Chief Strategist, Cambridge Associates rounded off the segment Participant Perspectives/Portfolio Positioning.

The Views of Our Friends

While the discussion across matters “inflation” was wide ranging, one particular view stood out: it does, currently, appear to be transitory. The factors seen as being behind inflation were both interesting and varied.

Factors Behind Inflation

In looking at secular inflation, following 40 years of deflation, one of our friends saw it as having four distinct pillars, i.e., themes, albeit that each of them is currently in transformation. These themes were: globalization—40 years of massive increases in global capacity; trade politics—a changing political climate; demographics—new demographic influences; and fiscal/money—monetary and fiscal policy. Our other friends approached inflation in a couple of different ways. One often models inflation in terms of growth rates, the concept of base effects and levels. Another friend felt that some of the most important drivers, from a secular perspective, over the past few decades were the opening up of India and China and the fall of the Soviet Bloc in the ‘90s.

Inflation: Transitory or Long Term?

Our guests could, broadly, be said to have agreed that current inflation looks transitory. One admitted to being, now anyway, a “modest” inflationist (having started this correction as a “deflationist” and becoming, then, a “stronger inflationist”), with a balance to some of the distortions that are deflationary in nature. (Inflation was seen, primarily, as transitory, with pockets of prices rises stronger than others.) Another guest thought it was almost impossible to have persistent inflation this early in the cycle, not least with excess labor supply, excess capacity and manufacturing supply across the world. Finally, our last guest thought that, near term, higher inflation was likely to be transitory and it was highly unlikely that we would see persistent inflation of 3% plus at any time over the next one to two years horizon. However, the deflationary forces have ebbed and could lead the way for higher inflation longer term.

So, What to do about it—Whatever sort of Inflation it may be

The opinions of our guests were, once again, varied. One, while accepting inflation as transitory, saw the need for the drivers behind it meriting further analysis. Another was pro risk assets, but with the understanding that they need to have a strong inflation response built. And that this is obtainable primarily from real assets, equities and any commodity related investments that an investor might be willing to add. Finally, there was the view that it was useful to look at the rate of change in inflation/deflation to see how certain asset classes performed and to look towards real assets that have a secular story behind them that can be potentially helpful in inflation, but that, regardless, are expected to have good returns.

Some Further Observations

In answer to the question whether the decline in the working-age population was potentially inflationary, the reply was that it was indeed a problem and potentially inflationary. In response to another question, for indications around inflation, you can look at prices, but they tend to jump around and are not that good for looking forward. It is, therefore, worth looking, in the background, more to such factors as persistent increases in employment and increases in manufacturing capacity utilization across the board. Technology, leading to increases in productivity, was seen as being a possible long-term way out of inflation.

The U.S. Federal Reserve (Fed) was not seen as having painted itself into a corner, but there were seen to be limitations now as to how much and what it can do. And it is trying to balance across the limits as it waits for a stronger growth environment.

Conclusion

We believe the afternoon was a success and we will certainly be seeking to add more to the series. It was interesting to note that there were no wildly diverging views among our guests, especially concerning the relatively transitory nature of inflation. But also around both the signposts for which to watch and the fact that we might be in for both a bit higher inflation and a bit higher growth and the fact that the Fed is supporting much of this with respect to policy. Finally, there was certainly an observed place for natural resources equities in a portfolio. Perhaps gold as well, depending upon your desired outcome. This appeared to be consistent, whether you were thinking about what is going on in overlays in pensions for managing risk. Or in the transition in the energy space. Or relative to value, where there is value in equities.

Our thanks to all for making this event possible, and we look forward to another VanEck & Friends Afternoon.