Inflation, for so long a low priority concern for investors, came storming back into the headlines recently with news that Australian consumer prices had risen at their fastest annual pace in almost 13 years. What are we to make of this?
The Australian Bureau of Statistics said the consumer price index, a comprehensive measure of goods and services price inflation, rose by 3.8% in the 12 months to the end of June 2021. This was the biggest rise since the third quarter of 2008.1
The statistician cautioned that base effects had contributed to the result as the CPI for the June quarter of 2020 had been held down by pandemic-related one-off effects, including the introduction of free childcare and a record fall in fuel prices.
In core terms, stripping out seasonal and temporary measures, inflation remained below the bottom of the Reserve Bank of Australia’s 2-3% target band, the bureau said.
Nevertheless, the Australian CPI result, coming on top of similarly eye-popping numbers in other major economies, was enough to trigger a flood of media commentary about the implications for investors of rising inflation and inflation expectations.
In one financial daily, a commentator wrote that despite assurances that the price jump would be transitory, investors had reason to be concerned that “unprecedented” policy stimulus would have a “very unpleasant after-effect in the form of rising inflation”.
Obviously, it would be nice to know whether the recent spike in inflation will prove to be anything more than a blip. But the fact is nobody really knows. Markets have already absorbed the news to date. And as new information emerges, expectations can change.
You only have to look at what has happened in the global bond market to see evidence of that. In March this year, US 10-year bond yields spiked to their highest level in more than a year above 1.7% on signs of rising inflation and increasing economic activity.
But yields then proceeded to backtrack in the second quarter as worries about higher inflation gave way to concerns about faltering economic growth.
The fact is inflation is only one of many factors that investors collectively take account of. Each day, there is news of progress or otherwise in vaccinations, earnings results, merger and acquisition activity, policy measures and economic activity data.
In Australia, the virus outbreaks and resulting lockdowns in Sydney and other cities have focused attention back on the implications for economic growth. The Reserve Bank has already flagged it expects GDP to decline in the current quarter.3
With uncertainties over health outcomes, the pace of the vaccine rollout, the future of border re-openings and what all this might mean for earnings, investment, consumer spending and prices in the months ahead, many people are naturally anxious.
For investors, there are a few points to make about this. The first is that the future will always be uncertain. There is always something to worry about. In fact, investors’ willingness to bear uncertainty is why there is the opportunity of return.
The second is that attempts at market timing – trying to get in or out of the market based on the latest economic data does not have a very good record of success. And even if you get your exit right, you have still to decide when to get back in.
The third is that there is solid evidence in Dimensional’s own research that just staying invested over the long-term in a diversified portfolio is more likely to give you a better outcome anyway, helping you outpace inflation and ride through the bumps.
The final point is that your first guide to what the future may hold is the market itself. There are data releases hitting our screens every day – on inflation, growth, manufacturing activity, unemployment, investment. Market prices, reflecting the collective best guess of millions of investors, already reflect this information.
Just staying invested can be the best strategy of all. Adjusted for inflation, $1 invested in the S&P/ASX 300 index grew to about $15 in the four decades since 1980. Bonds also outpaced inflation in that time, which included rising and falling inflation environments.
For investors particularly concerned about inflation, there are ways to hedge against unexpectedly large price changes beyond what the market has already factored in. One option are Australian Treasury Indexed Bonds, in which the capital value of the security is adjusted for movements in the CPI.
But keep in mind, if inflation does not move higher than the market’s expectations, that also means you can sacrifice returns.
In summary, news of the recent spike in inflation in Australia was quickly absorbed by market participants who as always are looking ahead to the next thing. Whether inflation will prove transitory, as central bankers assure us, no one can tell for sure.
For individual investors, it does not make sense to overreact to short-term fluctuations in consumer prices. Just staying invested in a plan made for you, or hedging as appropriate, can spare you a lot of angst.
1Consumer Price Index, Australia, June Quarter 2021, Australian Bureau of Statistics.
2‘The Big Inflation Conundrum Confronting Investors’, Karen Maley, AFR, 3 Aug 2021.
3Monetary Policy Decision, Reserve Bank of Australia, 3 August 2021.
AUSTRALIA and NEW ZEALAND: This material is issued by DFA Australia Limited (AFS License No. 238093, ABN 46 065 937 671). This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person. Accordingly, to the extent this material constitutes general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. Any opinions expressed in this material reflect our judgement at the date of publication and are subject to change.
Contributed by Jim Parker, Vice President Dimensional Fund Advisors