- Inflation is a real risk
- But we’re all probably too worried about it
- The behaviour of shoppers could hold lesson for investors
- But it’s always better to be lucky than right
- Loads of new idea generating data
Watching the stimulus cheques flow and the printing presses roll during the pandemic, many have come to the view that above-target inflation is inevitable. For much of the past year, many noteworthy market themes have suggested investors contemplating the scenario: the soaring gold price early in the pandemic; flirtations with crypto currency by some mainstream investors; the heralding of a new commodities supercycle; and the recent rotation from 'growth' to 'value'.
Earlier this month, Bank of America’s survey of global investment managers found inflation had taken over from Covid-19 as the biggest perceived risk to markets.
There are certainly good reasons for the popularity of this view. Taking the monetary experiments adopted following the credit crunch to refinance banks and using them to syphon money into consumers’ pockets is certainly novel for many leading economies.
But are markets perhaps getting carried away with the inflation story?
Shoppers may be able to offer some answers. Specifically, a study into the influence of shopping on views about aggregate inflation by academics Francesco D’Acunto, Ulrike Malmendier, Juan Ospina and Michael Weber.
The research found that shoppers' views on inflation were heavily influenced by increases in the price of items they bought frequently. The price of frequent purchases was far more influential than the overall cost of their shopping or prices throughout stores (the cost of the stuff they didn’t buy). What’s more, while price rises influenced their views on inflation, price falls had little impact.
This plays to what behavioural psychologists call 'availability bias' and 'recency bias': all people are found to attach excessive significance to events that are most attention grabbing (available) and recently experienced. So investors on the edge of their seats looking for signs of inflation can be expected to be more likely to find what they’re looking for and to put excessive significance on it when they do.
While there are reasons to think above-target inflation could set in, no matter how compelling the logic of these arguments, it is important to keep in mind it also may not happen. Japan, for example, first adopted quantitative easing (QE) to stoke inflation almost exactly 20 years ago. Government debt to GDP has since grown to almost 270 per cent. Yet neither has the economy managed to produce noteworthy price rises nor has the value of the currency collapsed (in part thanks to its importance as an exporter).
What’s more, despite all the talk of a spike in 10-year bond yields, we are only back to around where we were before the pandemic stuck. Perhaps not so weird given vaccines provide a strong reason to believe the worst of the Covid crisis could soon be behind the world. Likewise, inflation is coming back from a super-low base, too.
It’s true that the over-indebtedness of some companies and high valuation of some growth shares means even small moves could be consequential. But the human mind is extremely proficient at concocting and believing good stories. Behavioural psychology would suggest that investors are likely to currently be putting more faith in the inflation story than is warranted.
Perplexingly though, that observation stays true even if by overstating the inflation risk investors ultimately luck out. After all, while long-term investment success is about making right-sized bets based on the probability of future events, wrong-sized and lucky will always be a more profitable formula. The only problem with the latter approach is that its second input is a tad slippery!