Peter Brown: Stockmarket investors will have to watch inflation for years

Economic growth and corporate profits are decelerating as central banks become increasingly hawkish. 

Despite the horrible events unfolding in Ukraine many investors are surprised to learn that the markets are focused on inflation. The Ukraine war has exacerbated the inflation problem, but it wasn’t the cause of it because supply issues and labour shortages after the global lockdowns pushed up raw material prices. 

Alongside inflation, China is a concern as its tough lockdown strategy against Covid slows global growth. Also, we have an aggressive interest rate tightening policy in the US, with the Federal Reserve looking likely to raise rates again in May. All in all, the economic outlook has changed dramatically. 

Since 1960 there have been 10 quarters where three cyclical factors were all accelerating at the same time while central banks were cutting interest rates and government fiscal policy was at the same time providing stimulus. Stockmarket returns were some of the strongest in history during those quarters. 

Now many of those factors are going into reverse. Economic growth and corporate profits are decelerating as central banks become increasingly hawkish. 

The problem is that central banks have waited until very late in the cycle to hike interest rates. Inflation is not a transitory event; it is here to stay for a long time. In fact, we have yet to see the full effect of the Ukraine crisis on commodity prices.

Wage demands, industrial unrest and higher interest rates are all ahead of us. How damaging it will be to the Irish economy is unclear at this stage, but it will certainly lead to lower consumer spending and that leads to job losses. 

Ireland is better placed than most economies to withstand a global slowdown. There are still labour shortages and tech, and pharmaceutical industries continue to expand. We will of course spend a lot of extra money in supports both for those suffering from the rising energy costs and Ukrainian immigration. 

However, the cost will not be felt for a decade as that money is borrowed as part of our national debt at interest rates close to zero. In fact, interest costs on our national debt continue to fall as old borrowings mature and get refinanced at lower rates.

We think the inflationary impact of the war will hit corporate profit margins. We see a very high likelihood of lower growth and higher inflation, namely stagflation, in the US and in major European economies, in particular. This is driving US stocks lower. 

Many people are sitting with cash on deposit and are worried about value being eroded by inflation. At the same time, they see events as scary and are nervous of investing against this geopolitical background.

Portfolios that build for inflation are doing very well, as are climate change plays and value stocks. 

It is unlikely the correction on major stocks markets is over. The market main players are rotating away from big tech and growth stocks to value stocks and commodities. This will not be a short-term phenomenon but will  likely last years. 

• Peter Brown is managing director of Baggot Investment Partners [e-mail]