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Investing in an inflationary environment

Goola Warden
Goola Warden12/9/2021 07:46 PM GMT+08  • 8 min read
Investing in an inflationary environment
In TES' year end investment forum, sponsored by TDA, speakers highlighted the Fed's kokomo policy, and investing ideas
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The theme for The Edge Singapore’s Year End Investment Forum (YEIF), sponsored by TD Ameritrade and held on Dec 4, was titled Investing in an Inflationary Environment.

Christopher Brankin, CEO of TD Ameritrade Singapore, does not think the current bout of inflation is transitory. “Are we in some type of transitory inflationary period? Many economists will tell you that all inflation is transitory in nature. I’m not in that camp that this is a temporary period. At this point, we’ve seen [inflation] over the last couple of quarters, and it looks to be driving into the remainder of the year and well into 2022,” he cautions.

Vishnu Varathan, chief economist at Mizuho Bank, delved more into the technicalities of inflation. According to him, inflation is not caused just by rising oil prices or higher food prices. US consumer prices jumped 6.2% in October, the biggest inflation surge in more than 30 years, and the most since December 1990. US core inflation, stripping out food and energy, increased 4.6%, the fastest gain since August 1991. Something else, surely, is at work.

Pandemic caused inflation

As Varathan goes through his slides, it is increasingly evident that the genesis of the current inflationary trend is likely to have been caused by the pandemic — ironically. Last year, as the pandemic hit, much of the global populace did not travel, either across borders, or for services such as banking and shopping. The consumption of services fell, and this appeared to be substituted by the consumption of goods which were delivered through e-commerce.

“Because of the pandemic, we’ve somehow substituted services such as travel by buying durable goods,” Varathan notes. These are delivered through supply chains from sourcing to manufacturing, and transportation of goods.

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However, due to the pandemic, upstream activities slowed because people could not work fulltime. Similarly, workers in freight services at ports and airports had to work in shifts. The upstream cost-push elements — starting with commodities, all the way to freight costs — caused prices to rise.

As a case in point, the Baltic Dry Index, a proxy for freight rates, had surged more than 400% since April-May 2020, during the height of the pandemic (see Chart 1).

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“We can think about it in two ways. One is you’ve got too much money chasing too few goods, and/or you could have that supply-demand mismatch where your producers in your freight and your supply chain cannot keep up with demand. We’ve seen a bit of both,” Varathan says.

The services economy may be creaking back into action. In Singapore, five vaccinated persons are allowed to dine together. In the US, schools have re-opened for their autumn term.

Yet, new variants of Covid have emerged. So far, Pfizer-BioNTech have announced three doses of their vaccine is able to neutralise the new Omicron variant. If so, services could continue their resumption.

“To some degree, travel, and the resumption of the consumption of services, may alleviate some of the pressures on the supply chain,” Varathan notes. “Regardless of how it pans out, to some extent, some of the disruptions are going to be there. With reference to the supply chain kinks that we’ve seen this driving of inflation, there are two things to consider — the actual impact of the pandemic whereby there’s disruption to the workforce and disruption to workplaces, and the consumer,” Varathan continues.

He says once the workforce is fully operational, and backing up the entire supply chain, there is also the consumer aspect to consider. A lot of consumption is being done by e-commerce, and some of that will most likely persist, if the pandemic is controlled.

To put inflation in perspective, higher oil prices — which have already eased — and higher coal prices, particularly in China, have caused China to be a net exporter of some inflation. Since its entry into the World Trade Organization in December 2001, China had acted as an exporter of deflation. Now though, China is no longer an exporter of deflation, and could, to an extent, export inflation.

Kokomo policy option

For more stories about where money flows, click here for Capital Section

So, what are the policy options? Varathan suggests the US Federal Reserve is likely to opt for the Kokomo policy option. Kokomo is a Beach Boys song, and one of the lines is: “We’ll get there fast, then we’ll take it slow, that’s where we want to go, way down in kokomo.”

“Policymakers must be [thinking], we want to get there fast, and then we take it slow. So we will see some rate hikes coming in next year,” Varathan concludes.

His hypothesis is that starting in the middle of next year, with another one in place by the end of next year, the Fed is likely to raise the Federal Funds Rate. “The reasons why the Fed wants to get there fast is so that they don’t have to overstay and over-compensate later,” Varathan says.

These policy options are hinted at in the Fed’s dot plot. Each dot on the dot plot shows the view of each of the 19 Fed bank presidents. Shifts in the dot plot look increasingly hawkish (see Chart 2).

In the June dot plot, the consensus was for no rate hikes till 2023. In September’s dot plot, an impending hike is indicated for next year. The dot plot at the next Federal Open Market Committee meeting on Dec 13-14 is likely to be even more hawkish, Varathan reckons.

Robust US earnings season

Brankin of TD Ameritrade had positive news for attendees at the YEIF. “Despite higher costs and supply chain difficulties, margins were strong this earning season,” he says of the US 3Q2021 earnings reports. Approximately 82% of the companies in the S&P 500 Index beat street forecasts on earnings per share (EPS) and 75% of those companies beat on revenue. “These are very strong numbers, and better than expected,” he says.

At the start of 3Q2021 earnings season, expectations were already elevated, at 27% overall growth in earnings. “Throughout the earnings season, everything, from the banks to technology, continued to beat expectations and provided positive EPS and revenue surprises, moving the growth rate to 40% by the end of the earnings season,” Brankin indicates.

Out of the S&P 500’s 11 sectors, nine reported consistently higher numbers. The biggest disappointment was the telecommunications sector, Brankin says. As a result, Brankin says, customers of TD Ameritrade in Asia and the US were net buyers of stocks for 11 of the last 12 months.

“Lots of things that have been driving stock markets, not only in the US but globally, such as demand, has returned. Hopefully, this new variant does not derail a lot of that good,” Brankin says.

For one thing, US consumers have been strong, driving the consumer price index in the US higher. On the other hand, demand is causing everything to rise — energy, petrol, housing and vehicle costs.

Despite these inflationary pressures, TD Ameritrade’s customers are reentering the market to buy some of the big tech companies that were sold down, such as Alibaba Group Holdings, Baidu and Oriental Education, Branking indicates.

Grab, Sea are the future

Nirgunan Tiruchelvam, head of consumer sector equity research, Tellimer, discussed ways for investors to get an exposure to the digital economy of Southeast Asia. The pandemic caused a shift in consumption patterns, with the digital economy fulfilling both consumer needs for goods and services.

For the widespread use of e-commerce, consumers turned to a couple of super apps in Southeast Asia — Grab, which listed on Nasdaq on Dec 2 as Grab Holdings; and GoTo.

“You can not only procure goods using your app but you can eventually receive an education; you can receive health services. There are prospects for healthtech, edtech and a range of other businesses which was not possible before,” Tiruchelvam says.

“We have a super app concept coming in, where people are using Grab or GoTo to eventually receive a wide range of services,” he adds.

According to Tellimer Research, the gross market value (GMV) of Indonesia’s Internet economy has skyrocketed to US$70 billion ($95.5 billion) in 2021 from US$40 billion in 2019, and is forecast to rise to US$146 billion by 2025. “The number of people who have made at least one Internet purchase is a lot higher than even the wildest expectations of companies like GoTo and Grab,” Tiruchelvam says. Indonesia is going to be the centre of the e-commerce revolution, he adds. “

How do we make money from this whole exercise?” Tiruchelvam asks rhetorically. Well, Grab is a company that many in Singapore — and Southeast Asia — use on a daily basis, for ride hailing, food delivery and simple payments. “Grab is a potential super app in Southeast Asia where people would eventually access education, insurance and financial services,” Tiruchelvam says.

The other stock that is a proxy for Southeast Asia’s digital economy is Sea. “This stock produces an e-commerce portal called Shopee. It’s also a company that controls Garena, a popular gaming company. It is the largest company in Southeast Asia by market cap, at US$140 billion,” Tiruchelvam says. In fact, Sea’s market cap is higher than the total market cap of Singapore’s three local banks.

With their listing on Nasdaq, both companies are well capitalised. For instance, Sea has been very well proactive in raising money and could have a net cash position of US$13 billion, Tiruchelvam figures.

The dotcom bust that tech companies experienced in 2000 is unlikely on a global basis, he suggests, as Chinese tech stocks have fallen as much as 40% this year. At any rate, Tiruchelvam is a believer in a diverse portfolio in different asset classes.

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