Inflation

Given the new news of COVID in China, and the ongoing impacts of the Russian invasion of Ukraine, the near term outlook for inflation is one of upside risk.

It just ain’t gonna unwind (supply chains de-bottleneck) if China closes, and if the military conflict continues.

So, to that end, we can think about what kinds of stocks and sectors are going to benefit from sustained higher inflation.

You can answer such a question quantitatively, by regressing each sector/industry group against market implied estimates of inflation (breakevens, derived from Aussie TIPS equivalents, and nominal AGBs).

Sector

Regression to breakevens

Unsurprisingly, banks, resources, and insurance all come to the top. Food and Beverage also has some degree of implied pricing power. Note that in this analysis we control for movements in FX, oil, real rates and changes in real rates.

Note also the proportion positive section. That’s a helpful guide (in addition to the t-stats and p-values, but I won’t get into that here) as to how “real” the result is. There’s kind of no doubt about the impacts here for those sectors.

The asset management and custody grouping is the fund managers and platforms. Regressions are noisy, and it is likely that the fund managers are picking up the correlates of “strong-economy-=-higher-expected-inflation” more so than it is about passthroughs to inelastic end users.

Stock

Regression to breakevens

At the stock level, things are even noisier. The gold stocks all have a material negative loading to BE’s, which is plausibly getting conflated with negative loadings to changes in real rates, which in turn is being effected by the recent positive correlation to both, given Russian stockpiling of gold (which bid up in the price) as a means of attempting to pre-empt sanctions.

So you’ve really got to think your way through the data.

The other approach is more qualitative. Which stocks, during reporting season, indicated strong pricing power?

Amcor and Brambles had well publicised pass-throughs to end users. Many, but not all, of the consumer discretionary names did too. JBH in consumer electronics is another good example, as were some of the private health insurance players.

In our view, the retail names are challenged by the share of wallet shift (pull forward in demand, due to COVID, which now leaves a hollow log + higher mortgage rates, higher gas prices) leading to inventory overhangs and increased competition. Plausible, these are deflationary candidates.

The sectors that we already discussed (banks, resources, insurance) similarly had good outcomes, with QBE and SUN reporting some of the strongest gross written premium growth we’ve seen in many years.

In the current environment, the resource companies are the source of much of the inflation – iron ore, oil, copper, steel, and so we probably don’t need to discuss them here in detail.

Important Information: This document has been prepared by Aequitas Investment Partners ABN 92 644 165 266 (“Aequitas”, “our”, “we”), a Corporate Authorised Representative (no. 1284389) of C2 Financial Services, (Australian Financial Services Licensee no. 502171), and is for distribution within Australia to wholesale clients and financial advisers only.

This document is based on information available at the time of publishing, information which we believe is correct and any opinions, conclusions or forecasts are reasonably held or made as at the time of its compilation, but no warranty is made as to its accuracy, reliability or completeness. To the extent permitted by law, neither Aequitas nor any of its affiliates accept liability to any person for loss or damage arising from the use of the information herein.

Please note that past performance is not a reliable indicator of future performance.

General Advice Warning: This document has been prepared without taking into account your objectives, financial situation or needs, and therefore you should consider its appropriateness, having regard to your objectives, financial situation and needs. Before making any decision about whether to acquire a financial product, you should obtain and read the relevant Product Disclosure Statement (PDS) or Investor Directed Portfolio Service Guide (IDPS Guide) and consider talking to a financial adviser.

Taxation warning: Any taxation considerations are general and based on present taxation laws and may be subject to change. Aequitas is not a registered tax (financial) adviser under the Tax Agent Services Act 2009 and investors should seek tax advice from a registered tax agent or a registered tax (financial) adviser if they intend to rely on this information to satisfy the liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law.

Receive our investment insights

Something went wrong. Please check your entries and try again.