The return of inflation is clearly one of the top themes of 2021 and the post-pandemic economic revival. In addition to the temporary effects associated with supply chain bottlenecks (semiconductors, energy, copper, etc.) during a sudden upturn, there is the question of a potential change in the inflation regime. The alignment of monetary and tax policies around the world points to a potential ‘last battle’ to ward off the deflation risks of the previous decade and, in doing so, encourage higher inflation. The ambition of this study is to look at how to adapt equity portfolios in this scenario.1
This structural rise in inflation, if confirmed, harkens back to the period in modern history that spanned the end of World War II to the early 1980s. In reality, we can distinguish between two sub-periods. We have set them apart by naming them after the seasons of spring (1949- 1966) and summer (1966-1982). Each season has strong characteristics, and inflation happens to be one of them.
- Spring (1949-1966) was a period of sustainable growth, with slight but not excessive inflation. As WWII drew to a close, the economy’s productive capacity had to be completely overhauled. Interest rates and wages were at an all-time low. Banks that survived the economic winter had the financial resources to roll out the major innovations of previous years through multiple applications found by their markets (home appliances, automotive, aviation, etc.). A positive spiral took hold (falling unemployment, rising wages). Corporate profits picked up, although margins hit a ceiling. Deflation risk became a thing of the past and inflation risk was moderate.
The world today is similar in many ways: we need to build a low-carbon economy and there are inequalities at play, leading central banks and governments to align their monetary and fiscal policies.2 Similarly, many banks made it through the 2008 financial crisis and their solvency ratios are robust enough to fund new projects centred on climate change, digitisation and biotechnologies. Global competition (especially between the US and China, between historic auto manufacturers and Tesla, etc.) is forcing more and more players to invest just to stay in the race. Ultimately, interest rates, though still very low, are bottoming out.
- Summer (1966-1982) was a period of excess that marked the peak of inflation. Starting in the mid-1960s, new productive capacities were no longer sufficient and wages climbed faster than productivity. A vicious price-wage spiral made price rises the main feature of the period, which ended with a major recession. To be more specific, summer can be broken down into two shorter periods. The 1966-1971 phase ties in with the Vietnam War3, coupled with a tense social climate4 and wage demands backed by powerful unions in a much more industrial, fast-growing economy than the one we have now. 1971 marked the end of the Gold Exchange Standard and the beginning of another sub-period. The steep depreciation of the dollar and two oil shocks sent inflation skyrocketing to new peace-time highs.5
Inflation conditions from the mid-1960s (averaging 4% from 1966 to 1971) were higher than current levels, if we acknowledge the temporary nature of current inflation figures (Amundi estimates: 4.3%, on average, in 2021 in the US, 3.2% in 2022 and 2.7% in 2023). However, the share of wages in value-added, for example, which is currently close to what it was in the early 1950s, is expected to climb and end up having an inflationary impact a few years from now, especially considering politicians and central banks alike are now focused on the matter.
That being the case, we will examine trends in the US equity market, sectors and styles during these two historic economic seasons (spring and summer), and suggest portfolios that would have made sense at the time. Before that, however, we will highlight the mechanisms underlying the equity market’s response to inflation.