Inflation continues to be on everyone’s lips. The debate as to whether inflation is transitory or structural in nature is gaining momentum as the US recorded an annual rate of inflation of 6.2%, the highest rate in three decades. What is interesting is that we are observing a growing divergence between what is driving inflation in different countries, which is making the debate between structural and transitory inflation more nuanced.
There is no doubt that supply shortages related to COVID-19 have been putting upward pressure in input costs for many companies around the world. In recent company meetings conducted by Lonsec, rising input costs were a common theme for many companies across a broad range of industries. These pressures should ease as supply chains reopen and as we emerge out of the pandemic, which is consistent with the transitory narrative.
From an Australian perspective, wage growth continues to be sanguine. Apart from certain industries such as hospitality, where staff shortages are pushing wages up, with some restaurants indicating that dishwashers are asking for $90 per hour due to staff shortages. Wage growth, or the lack of, has been a key focus for the RBA and while wage growth remains low, the prospect of a rise in structural inflation is lower than other countries.
In the US the situation is different where we have observed core inflation rise, where inflation has not just been the result of rising energy prices. We are seeing evidence of wage growth driven by labour shortfalls and a reduction in productivity. It will be interesting to see how the US responds to the rise in inflation. One plausible scenario is that the US will seek to import deflation through appreciation of their currency. From an Australian perspective, this would put downward pressure on the Australian dollar and furthermore see US inflation effectively exported offshore.
While we are cautious on the prospect of inflation our base case is not one of out-of-control inflation. From a portfolio perspective, we continue to hold assets with underlying holdings where income streams are linked to inflation. This is particularly relevant for retirees where real income is important. This includes real assets such as listed infrastructure. More broadly while we remain pro-risk assets, the environment is becoming more challenging. We are observing more divergence in returns within asset classes which we think will make bottom-up investment selection an increasing contributor to returns in coming years.