How inflation impacts your portfolio

AXIAM invests in companies essential to humans, have pricing power (the ability to raise prices) and have limited debt.

Your portfolio and inflation

Inflation has peppered the headlines of late. Economists debate whether inflation is entrenched and requires action from the US Central Bank or is transitory, requiring no action.

How do central banks respond to inflation?

Central Banks manage inflation by raising interest rates, which have the effect of sucking money out of the economy as all debt becomes more expensive because debt payments increase, leaving less money to pay for goods and services. Because there is less money chasing goods and services, demand decreases, and prices stabilise.

At the time of writing, US interest rates are the lowest in history. The US Federal Reserve has announced a “tapering” of their bond-buying activities. Bond buying keeps interest rates low (the more money flows into bonds, the higher the value of the bonds and the lower the rate of interest). Low-interest rates drive up asset values causing markets to boom, as they have since the COVID induced sell-off in March 2020. While the US Central Bank will taper the bond-buying, there is no sign that the US Central Bank will raise interest rates. It is not possible to predict when rates will rise. Interest rates must rise quickly to cause the market to decline.

Moderately rising interest rates in a rising market represent a regular credit cycle that has characterised the markets for decades. Rates and markets rise until they reach a tipping point where money moves out of shares (causing stock markets to crash) and into bonds, causing bond yields to start declining.

How your companies respond to inflation

Our companies are well-positioned for inflationary cycles as their brands allow them to increase selling prices, and they are focused on the countries with the highest GDP per capita. Wealthy consumers in these rich nations are willing and able to pay more for the brands they like.

They are also well placed to deal with credit cycles as they have little debt and generate lots of cash.

Ability to pass on costs

We have seen Procter and Gamble, Unilever, Walmart, Nestlé (to name a few) acknowledge the increased costs of raw materials, and their response has been to raise prices for their products.

Ability to repay debt

AXIAM’s companies have minimal debt, so they can easily repay bondholders if rates do rise. Good companies succeed in periods of low and high inflation and periods of low and high interest rates. It is difficult for companies without brands to prosper during inflationary periods—companies with poor cash generation and a reliance on debt struggle to survive high interest rate environments. Periods of high interest rates are typically challenging for the markets but provide opportunities to buy great companies at depressed prices.

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