A terrifying forecast of 7% compounding UK inflation and a flight from cash, followed by a inflationary recession by next year based on the quantity of money, by Professor Tim Congdon of the IIMR/University of Buckingham.
RPI now at 7.5%. BOE rates still forecast at sub 1% this year.
But - the BOE claim it will come down on it’s own as it’s transistory.
What to do?
Hi,
Obviously, I wouldn’t increase my cash, but you know that already.
I would hold companies with pricing power.
Additionally, and according to Terry Smith, companies with high gross margins can accommodate inflation better than others because they can absorb raw material price increases without impacting margins too much. I agree.
Perhaps we should just get on with analysing companies and ignore the macro. I.e. concentrate on what an investor can control. (I’m not big into gold or bitcoin as a hedge. My brain is too small to deal with that).
So, for me, I am not doing anything, but just because my portfolio is positioned that way already.
What do you think is the best thing to do?
anon
Because this is large coordinated moneytary inflation, not credit inflation created by the commercial banks as in 2008, due to low interest rates, assets will not collapse in quite the same way. House prices may not do as badly as stocks this time around.
In 2008 Banks didn’t trust each other because of bad credit. Interest rates rising and tighter money this time will not really affect the banks - they are flush with (printed) reserves.
I imagine if I was a working man in 1971 I bet I would be in disbelief at houseprices at a index of 250 on my mergre salary. By 1972 they had almost doubled. By 1974 up only 35%. But I can gurantee I would be too buzy out marching with my shop steward in my ‘closed shop’ for 2 hour long tea breaks and a tea break bonus and screaming at scabs while fighting for a 50% pay rise to notice!
If anything rising long bonds (if we get a steeper curve) will create positive profits for banks. But in all moneytary inflationary booms (eg; Barber Boom of 1972) The Barber Boom | Thinking | Ruffer | Investment Management real money balances shrink and the economy enters a slump.
If anything houseprices rose sharply all through the 1970s. It was stocks (and the pound) that suffered.
“In May 1972, the FT30 reached a peak of 544, but then dropped 75 per cent before bottoming out in January 1975. Even then, it took more than four years to recover its 1972 level and then didn’t consistently trade above that until the early 1980s.”
(Subscribe to read | Financial Times)
IMO there is going to be a nasty shock within months to the market from this inflation. If the BOE doesn’t response to this inflation then factors of production will be bid up, there will be a flight out of cash, causing more inflation and unions will be rampant. If they do respond by higher interest rates, and meaningfully tighter money, then a recession will be induced.
Hi Muscleriot,
You have the weight of the world on your shoulders!?
Yes, you and The M are both right. This outcome is entirely possible and maybe probable.
I have a house and don’t need another one. The tide seems to be turning against the private landlord in terms of the rules.
If I didn’t have a house, I would buy one, and ignore the current income multiple. They have always seemed expensive to me.
Re stock multiples. Not my problem - I look at the cash yield at the current price and estimate future growth. I can’t control p/e contraction and refuse to hold cash long-term.
Re exchange rate, a lot of my portfolio companies have foreign revenue exposure, which mitigates the currency risk. I don’t factor currency risk at all in my investing. I haven’t got a clue about it 
A flight out of cash to which asset class? Shares seem to be the only viable alternative unless one tries to time a gold trade. That seems more risky to me, though.
In terms of Unions, I think employees should be paid more. Hopefully, though, unions will be congnisant of the fact that the more they press on wages, the more automation will take jobs away from their members. One can hope!
Investing-wise: I still would not do anything differently. Optimists have won over the long haul and I won’t believe otherwise, if only because second-guessing macro factors would send me into a purgatory of self-doubt.
Also, I won’t invest on margin. The only margin I would consider would be to buy my own house, if I didn’t have one, with the margin being a mortgage.
Personal finance-wise: I am not entering into any long-term financial commitments and ensuring I can live on little, if needs be. Boring but practical!
anon
In times of strife and discord, it seems eminently reasonable to take a stoic approach and focus on things that you can control or influence. So, if real interest rates are low, don’t hold too much cash. If you hold equities, think hard about pricing power and cash generation. So if a company depends on regularly discounting its stock, such as DFS, think hard about whether it can generate profits if input costs rise. Make the problem manageable rather than trying to assess the impacts of hundreds of badly measured variables that you cannot influence.
From Equities: a false sense of security | Thinking | Ruffer | Investment Management
Is there a safer, more defensive, inflation proof stock than a candy company with a well known and loved brand? It has pricing power. It is immune from a large workforce and huge expenses, a fall in demand or product substitution. It’s earnings are inflation-proof. Here is the performance of US company Hersey’s in 1972 when inflation started to rise from 3%.
What value is a future pound when 7% is devalued in a year and 7% the next year? Compounding inflation… You buy a company for £26. It has future inflation-proof cashflows with 2% inflation worth a Price of 16x Earnings at £1.50, so what do you care about inflation… You find it’s STILL PUNISHED the inflation adjusted Price of those future Earnings, which may have almost doubled to £2.50 - due to inflation - are only worth 6x at 7% inflation… for a shareprice of £16… The EARNINGS are inflation protected - the PRICE you paid for the earnings are not inflation protected!
Hi,
Fair point. PE contraction is a fact of life with equities, unfortunately, and certainly adds to volatility.
If one were to go down the multi asset route volatility would be less, but so would returns imo.
(I’ve charted the frse250 ex it with Ruffer and Fundsmith below).
If you feel like equity volatility may make you puke trade (apologies, I hate that term!), Ruffer may be a viable alternative and suit your personality better.
Good luck with whatever you decide to do,
anon
Hi,
Final comment - from the below table. It isn’t that Berkshire Hathaway achieved 22.2% p.a. during the 70’s but that the S&P index achieved a nominal 5.9% p.a. during the 70s and a nominal 9.8% p.a. from 1965 to 2014.
Admittedly the average 1970s inflation rate was 7.25%.
Obviously this is dependent on someone sticking with the stock market during bad times i.e. not selling at the low and not buying at the high. Easier said than done! (unless one remains materially invested during the bad times).
(I personally think Ruffer are talking their own book, as they should, but I take your point).
anon
Buffett didn’t stick with the market during the 1970s
He dissolved his partnership in May 1969 saying he saw few opportunities to invest amidst high valuations and wanted to retire but would keep Berkshire (a textile mill) and a few other operations going. https://web.archive.org/web/20140323164901/http://www.rbcpa.com/web_letters/1969.05.29.pdf
After this the overvalued market crashed.
Hi
Interesting article, thank you!
I wasn’t really referring to Buffett or Berkshire Hathaway, but the overall market return. Maybe I didn’t make that clear.
That said, If you think you can time the market, a la Buffet, go for it! I can’t - I wish I could 
The answer is do what is best for your personal investing psychology.
Good luck 
Over and out.
anon
Apologies- one final comment:
The final section of the Buffett article which you kindly referred to is this:
Whatever the level of reported profits (even if nil), more dollars for receivables, inventory and
fixed assets are continuously required by the business in order to merely match the unit volume or
the previous year. The less prosperous the enterprise, the greater the proportion of available
sustenance claimed by the tapeworm. A business earning 8% or 10% on equity often has no
leftovers for expansion, debt reduction or “real” dividends. The tapeworm of inflation simply
cleans the plate.
Rather neatly, this points to investing in high return and high margin companies. Which takes me back to my first post on this thread:
Generally these will be companies with high ROE and ROCE.
One can’t buy bonds if yields are to increase because their value will fall. I’m not a fan of gold or cash, so I have to stay with equities.
Thanks - it’s been an interesting exercise in considering inflation.
anon
Hi,
From the Smithson letter, published today, on the topic of moderate inflation:
Of course, interest rates are on the rise because central banks are trying to contain inflation, which many fear may not be transitory, as first thought. It is worth mentioning that we do not fear moderate inflation, which by itself would likely not cause a significant problem for our companies. This is owing to a couple of reasons. First, the companies we own have high gross margins, and therefore low raw material costs. They also tend to have low capital requirements, which allows them to generate high returns on that capital. As inflation affects both the cost of raw materials and the cost of plant and equipment, those that spend less as a proportion of revenue on these items will be relatively less impacted by cost inflation. On top of this, the market structure and competitive positioning of many of our companies mean that they would also be in a position to raise the prices charged to their customers should the costs of the business increase. This is not necessarily something we want them to do unilaterally; as a market leader raising prices can often create an ‘umbrella’ under which competitors can flourish by charging slightly lower prices while still maintaining a good margin. But if inflation is creating a cost issue for the whole industry, it is comforting to know that our companies have the market power to increase prices should it become necessary.
Admittedly it is a PR document, but the whole letter may be worth a read, if time permits:
Microsoft Word - Smithson Letter to Shareholders 2021 FINAL
anon
A ‘Terry Smith type’ High ROCE - reinvestment compounding inflation-proof business (HSY) during the inflationary decade of the 1970s compared to Newmont mining (i.e. a proxy for GOLD showing the distrust and eventual disinvestment from cash leading to possible hyperinflation). 10 years of going nowhere.
Why? Because inflation is a corporate tapeworm absorbing working capital and revenue as Buffett observed. The price paid for the high ROCE earnings had to be constantly rerated as the future value of money collapsed and interest rates rose.
Moderate inflation is below 3%, with interest rates above it by the Talyor Rule. It is not 5-7% with negative interest rates.
At the moment the dance of musical chairs out of cash to the least negative real yield ignores all risk. But with continuing negative real rates, and higher nominal rates, and higher costs, wages, raw materials, taxes - rerating is all but certain.
Hi muscleriot,
Back in 1979, HSY had an operating margin of 10.5%, gross margin of 28.2%, roce of 23.5% and roe of 16.4%, with an f-score of 1.0. (I can’t see their metrics, from earlier in the decade, unfortunately). Not a bad company, but not great.
Comparatively, my portfolio, has an average operating margin of 30.8%, gross margin of 61.3%, roce 33.9% (rooce 42.51%) and roe of 45.5%. Average F-score of 6.1. Debt to market cap 4.1%.
I feel fine about it. It is, in aggregate, a better ‘company’ than HSY was in 1979, all other things being equal.
I agree a re-rating is certain at some point in the future, in a downwards direction. Afterwards, though, it is equally certain to rerate back to where it was, at some point. If individual company profits are higher at that point, the portfolio will be worth more than it was at it’s previous peak.
Again, from the Smithson letter, imagine you have a lovely Labrador or a ‘mad as a box of frogs’ Spaniel and you are enjoying a summer stroll through the glorious British countryside:
Imagine a dog walker crossing a field, their dog wildly zigzagging around them. We would relate the companies we own to the walker, clear in direction and making steady progress across the field, while the daily market price is like the dog, moving back and forth quite randomly. Now, the current economic storm may well send the dog cowering for cover, but given enough time, we know that the price and value will eventually meet again, just as the dog and walker will ultimately leave the field together. We are also confident that, as well as making constant progress, a high quality company, if it trips during the storm, will rise again and keep going. Low quality, value companies on the other hand, may never get back up
This quote doesn’t answer the asset allocation question, but it does suggest quality companies will carry on and progress.
Indeed there is the argument that during tough economic times the stronger companies will gain market share at the expense of weaker competitors (who cannot deal with the tougher environment) and come out of a recession better positioned to benefit from the upturn, their competitive advantages enhanced.
As for gold, I won’t invest in it, for the same reasons I wouldn’t invest in bitcoin. Neither do anything for the benefit of people or society. They take up scarce resources, which should really be allocated else-where. (Gold looks quite pretty, I suppose, but it has limited industrial purposes).
(With respect to HSY, maybe it is worth taking 10 years of going no-where in return for a 220x performance of the following 40 years, in nominal terms, which is possible if you believe in the company?)
anon
Hi muscleriot
You mentioned house prices in the above thread.
I know the below videos made by a stockbroker, but I do tend to agree with what he is saying, and I don’t have any axe to grind, personally:
Tim anonnett Explains: Property or shares? (Part One) - YouTube
Tim anonnett Explains: Property or shares? (Part Two) - YouTube
anon
Unilever results interesting in this regard, given it is one that Fundsmith holds, although he has been slagging it off in public recently. Any way probably one of those high return businesses with pricing power as demonstrated in the results today. They are however expecting a hit to operating margins this year due to the current inflationary cost pressures.
"We currently expect very high input cost inflation in the first half of over €2 billion. This may moderate in the second half to around €1.5 billion, although there is currently a wide range for this that reflects market uncertainty on the outlook for commodity, freight and packaging costs.
The new organisation is expected to generate around €600 million of cost savings over two years. We plan to maintain competitive levels of investment in marketing, R&D and capital expenditure through a period of inflation-led gross margin pressure until input costs normalise and the full extent of pricing is reflected.
2022 underlying operating margin is expected to be down by between 140bps and 240bps, so maintained between 16% and 17%, with the first half impacted more than the second half. We expect margin to be restored after 2022, with the bulk coming back in 2023 and the rest in 2024."
So even they are suffering in the short term, but I guess it backs up his point that high margin / high return businesses have more scope to pass on price increases and wear the pain in the short term more easily, although the stock is off today on the back of it.
Hi JamieS,
Yes, I do think ULVR would be a good company to hold should inflation rocket.
On the Terry Smith comments, he may be one to whom some younger members of the population may say ‘ok boomer’ to?! (He would probably be quite proud of that from what I have seen!).
I’m not criticising him. I do agree with what he said on Helmann’s and that management are taking the ESG thing a bit too far. Having said that, taking ESG too far is a better option than ignoring ESG altogether in the long term, imo, and good for positioning the company for the future.
If ULVR hit their free cash flow forecasts, over the next 3 years, it’s difficult to see the share price not increasing, to keep the fcf yield down, or at least holding it’s real value if a higher return is required from shares to compensate for increased base rates.
anon
As Shares Magazine points out it has some activists on the register now too, so may be interesting down here in a wobbly market perhaps?
The drum beat of calls for change from investors in food to household goods conglomerate Unilever (ULVR) seems to be growing louder by the week if not by the day. The Financial Times reported over the weekend that after the firm’s failed £50 billion bid for GlaxoSmithKline’s (GSK) consumer health business, two major shareholders are demanding a shake-up.
Hi,
Yes, management have needed shaking up for a while imo, and I personally don’t have confidence they will hit their FCF targets.
It’s been too easy for them. I’m tending towards my current investment in Microsoft, for now at least:
| ULVR | |||||
|---|---|---|---|---|---|
| 2000 | 2021 | % change | RPI change | Real change | |
| Sales | 48,313.0 | 50,801.0 | 5.1 | ||
| Direct Costs | (21,925.0) | (28,684.0) | 30.8 | ||
| Admin Costs | (19,131.0) | (12,673.0) | (33.8) | ||
| Operating profit | 7,257.0 | 9,444.0 | 30.1 | +76.10% | -45.96% |
| Share count | 3,483 | 2,629 | (24.5) | reduction in share count | |
| MSFT | |||||
| 2000 | 2021 | % change | RPI change | Real change | |
| Sales | 22,956.0 | 168,088.0 | 632.2 | ||
| Direct Costs | (3,002.0) | (52,232.0) | 1,639.9 | ||
| Admin Costs | (8,948.0) | (45,940.0) | 413.4 | ||
| Operating profit | 11,006.0 | 69,916.0 | 535.3 | +76.10% | 459.15% |
| Share count | 10,566 | 7,519 | (28.8) | reduction in share count |
Also, I’m unsure if the ULVR definition of ‘Admin Costs’ has changed between 2000 and now, but if it hasn’t , ULVR must be getting close to the bone on admin costs, now, with further scope to cut being minimal.
(I don’t hold ULVR).
In other words, is ULVR on a:
Talking Heads - Road to Nowhere (Official Video) - Bing video
anon
This is a super bubble
“If you think you can stand it for 10, 20, 30 years then sure - stay invested.” Calling a Super Bubble: Front Row With Jeremy Grantham - YouTube
Jeremy Grantham.
Bubble valuation
Why? Their GMO Inflation compresses multiples according to the GMO model.
