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Amber Sinha, senior portfolio manager, CIBC Asset Management.
Why the investment community, I think, is focused on inflation more so now than in the past is that I would say for two reasons. One is that prices are at high levels, so that’s definitely a concern, especially given the fact that several aspects of the economy have not even come back fully. So if you have high prices and a weak economy, that’s definitely not a recipe for something good.
And the other question I think in people’s minds is, “Is this thing going to last? Is this transitory inflation? Or is this something that’s going to stay with us?” And I think that’s the more important question.
So the first question, prices seem high. Yes, they do seem high, they are high. But again, they are higher than what normalized inflation should be, but they look especially high compared to the inflation we’ve seen in the last decade. Because remember, over the last decade, which is 2010 to 2020, we’ve seen inflation at very low levels, despite very loose monetary policies.
So after 10 years of no inflation or low inflation, if you are printing high inflation numbers, it’s certainly … I will say that the current prices are reflective of certain disruptions in the global economy. So whether it’s on the production side, transportation, logistics, supply chain, what have you, and this is largely because of COVID. Once COVID is firmly in the rear view mirror, we expect a lot of these disruptions to go away, and a lot of things to normalize. So as the demand and supply picture normalizes with time for a lot of things, I think prices will revert back to where they should be. So when demand and supply are in order, you should expect crude oil prices or copper prices or rents to go back to what they should normally be.
But there is also the element of wages. And that’s where I think wage inflation is likely to stay. So while corporate prices can go back down, crude oil prices can go back down, rents can go back down, wages generally tend to be sticky. So if wages go up, they don’t generally tend to go down that easily. And we have seen, because of how tight the labour market is, we have seen large pay raises, the likes of which we haven’t seen over the last 10, 20 years, in recent times. And that certainly feels to us like a step up in labour inflation of wages in the current economic system.
Overall, I would say we have a mixture or a combination of two things. One is more transitory factors on the commodity side, and more structural factors on the labour side. So while we do expect inflation to normalize from here, I don’t think we are going back to no wage gains like we have seen over the last 10 or 20 years. So I think wage gains are here for us to stay.
With the current inflationary environment, and certainly the uncertainty that comes with it, what are we doing in our portfolios? What does this mean for our portfolios? Now while we remain fairly confident that at least some aspects of the inflationary pressures will go away with time, one can’t be 100% sure in this business. So we want to have a portfolio that should do well in multiple scenarios, including one in which inflation stays higher.
So what are we doing? Our portfolios, I would say, generally skew towards higher quality dominant franchises where pricing power is better than in some other areas. So think companies like Sony or Samsung versus unbranded, Chinese, [inaudible] electronics. Think of Nike versus private label yoga wear.
So I just think that the kind of companies that we generally skew towards have the ability to pass on prices and therefore maintain margins in a higher inflation environment, so we feel good about that. What we are trying to do in terms of, shy away from, so we are trying to avoid certain types of business models right now, given the inflation uncertainties. And these would be businesses that have high fixed cost bases, and especially high wage bills. Because like I said, I don’t think wages are going back down, like the way other commodities can. So certainly, a little more cautious on companies that have inflexible cost structures with regards to labour in particular.
The other way our portfolios can get impacted with inflation if this were to persist, we would likely see interest rates go up in response. And again, in our portfolios, because of the defensive high quality characteristics, those portfolios can lag when the cyclical elements of the market come back in a big way. So if you have high inflation, interest rates going up, that generally tends to be difficult for our portfolios in the very short term. And that’s because with clients’ money, we can’t move the portfolio as quickly as the market can take the 10 year rates up and down. So it takes us a while, but we remain confident that high quality defences are the way to go.