Inflation is a wild beast – here are 6 experts to show you how to shield your portfolio from it
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We tapped the brains of six experts in the field to find out where the safest place to put our money is, as fears grow that a recession may well and truly be on its way.
When the US sneezes, global markets around the world catch the cold and though Australian inflation numbers are nowhere near as bad (yet), experts say we should expect to see interest rates continue their upward trajectory.
Latest inflation numbers out of the US saw the consumer price index (US CPI) rise like a birthday balloon – 9.1% over the past year – and US gas prices surge nearly 60% compared to just over a year ago.
The energy index rose 41.6 per cent over the last year, the largest 12-month increase since the period ending April 1980, and the food index increased 10.4 per cent for the 12 months ending June, the largest 12-month increase since the period ending February 1981.
Capital.com’s head of trading Brian Gould told Stockhead we are in that quandary now where you have to get those rates up quicker and deal with the fallout afterwards.
You have to try tame the beast that is inflation “because when you raise rates in a slowing growth market, that can trigger recession which is the big R word everyone is talking about,” he says.
“Markets are going to put pressure on the FED to go for 100, particularly with The Bank of Canada raising rates to 100 – if they can do it, the US certainly can.”
With all this in mind, we asked five other experts in the field – which are the best sectors to put our money into? Should we prioritise large caps or small caps or should we really be locking our money away in bonds, cash savings or stocks?
There is a perception that flight to safety means investors should buy up gold in a recessionary environment, but So reckons the precious metal is no safe haven in these uncertain times.
The situation we are in now is unlike any other we have experienced in the last five or six years, he says.
“We are experiencing very high inflation, which is causing interest rates to rise very quickly and when that happens, the US dollar and all other currencies become more attractive because it’s paying a higher yield,” he says.
“In a world where interest rates are low and inflation is high, then gold is a good hedge against inflation but when governments and central banks start raising interest rates very quickly, gold loses a bit of that defensive element.”
This is when it is best to hold on to a diversified portfolio, which according to So, includes a combination of defensive stocks with exposure to energy, budget retailers, and gaming and entertainment companies.
In a recessionary environment and when consumers are tightening their belt, budget alternatives will be the ones consumers pivot to for their day-to-day necessities.
“I think it is important to note that it has been demonstrated the market can consistently produce between 9-14% of compounded returns over the long term of say 10 years,” he says.
“Based on that, one would expect that if you bought into the market now, you are going to get even higher returns than the average because the market has been falling and you’re coming in at a much lower point than you would about six months ago.”
In terms of defensiveness, the energy sector is the place to be as high oil and gas prices are likely here to stay.
“Australia’s domestic gas situation is at significant shortage and it’s going to take years to fix that.”
Just to be clear, if you’re a retail investor and don’t have to have a certain percentage of your portfolio invested at all times, then the best place to sit is cash, Berridge says.
“All sorts of opportunities can present themselves if you’re sitting on cash when no one else is.
“That said, irrespective of whether we have a Western world recession or not, it seems quite clear that decarbonisation will be ever present through the economic cycle so stocks exposed to this thematic would be the first place I’d look.”
Berrdige is keeping an eye on lithium producers such as Pilbara Minerals (ASX:PLS) and Allkem (ASX:AKE) – just a couple of the lithium stocks that have been sold down almost 20% in the last month, despite prices rising.
“It seems clear that as part of its stimulatory efforts, China has chosen the EV industry as a key beneficiary, which is positive for EV sales and lithium demand,” he adds.
“A bit closer to home, the other decarbonisation stock which I believe will have a big FY23 is GenusPlus (ASX:GNP).
“For the last month there’s barely been a day where the east coast power shortage hasn’t been on the front page and the bottleneck to bringing more renewable power supply into the grid is the distribution network.”
The Federal Government has committed $20bn to improving the grid, and the sense of urgency here is now acute.
That utility scale work and associated annuity style maintenance income complements a large pipeline of remote power generation projects tied to miners’ decarbonisation efforts, the latter being a key driver of GNP’s revenue growing from $12m to roughly $400m over the last four years.
Unfortunately, Dawes says small caps will only start to pick up again once interest rates fall.
“That is probably another year and a half away so you kind of have to stay in the large caps to hunker down and protect the portfolio.”
While there is much talk about the current economic crisis, we mustn’t forget about that little energy crisis we are also in the midst of and according to Dawes, there’s only a few ASX stocks set to benefit.
Worley Parsons (ASX:WOR) is an engineering business traditionally involved in oil and gas “but lately they’ve been focusing on green assets,” Dawes says.
“Shares in the company are up 19% year to date and may be higher in the next couple of years – there is a lot of money that needs to be spent on getting businesses up and running by 2030 and 2050 and they are well placed to capture that.”
His other pick is pipeline business APA Group (ASX:APA).
“It’s a bit of a long bow but it’s a defensive business and it’ll take a clip of any gas that is moving through pipelines – more and more gas is needed to flow through the pipes to make sure everyone can keep their lights on.”
With inflation running rampant and a rising interest rate environment, from Knight’s point of view investors should be backing businesses with pricing power, strong cash flows, a healthy balance sheet, and strong or growing competitive advantage(s).
“Our preferred pick here is Kelly+Partners (ASX:KPG) which is an accounting business that has grown its revenues at a 16-year CAGR of 30%, grew during the GFC, has consistently raised prices, has strong cash flows, a reasonable balance sheet, and profit margins that are ~74% higher than the industry average.
“We’re also backing profitable businesses with strong growth plans even if they face some short-term headwinds.
“Viva Leisure (ASX: VVA), for example, operate 150 gyms with a target of 400 by 2025.
“Gym membership held up reasonably well in the US during the GFC as people need an outlet during tough times.”
While the ride may be bumpy in the short-term, the outlook is promising, and the stock is trading for almost a third of its ATH in December 2020.
“Plus, you’re getting all the growth for free,” he says.
Associating size with safety can be misleading; just because a company is a large cap doesn’t mean they aren’t in a riskier end of the investor spectrum.
Take for example iron resource companies that sell into China.
If we enter a deep recession where the Chinese economy is not able to prop up the Australian economy for its purchase of iron ore, we could see these large cap companies fall very significantly.
Knight says on average, the length of time a company stays within the S&P500 has been in constant decline for decades.
“Companies are getting disrupted at faster and faster rates and returns are driven by 1% of companies with two out of three companies underperforming US T-Bills.
“In other words, the few winners keep on winning – think of Walmart, Apple, CSL and REA Group.”
Through cycles, it’s important to have a tilt towards outlier companies and the conviction to hold through the volatility.
“We’re prioritising that through quality companies (as mentioned above) and stock specific theses.”
As well as creating a diversified portfolio and taking a closer look at defensive stocks, which often translate into long-term share price growth, Mavridis says investors should be putting money into stock with long-term potential.
“CSL is a solid healthcare stock, trading at a discount year-to-date,” she says.
“The company sees consistent increases in earnings and sales and provides essential products in the healthcare industry.
“Woolworth is another one to consider, selling basic needs that will allow the company to continue to deliver steady earnings and sales figures, irrespective of economic conditions.”
Investors should really be limiting the exposure to any single risk, she says.
“A combination of defensive stocks and ETFs is a great foundation to a long-term plan, now that we’re seeing higher costs feeding through to margin pressures on most sectors.
“ETFs provide liquidity, transparency, and simple diversification across asset classes or investment themes.”
One way to diversify through ETFs is to broaden your exposure to global stock markets and complement your Australian equity portfolio with international equities, she says.
“The sharp selloff in global markets over the last six months means investors can now purchase company cashflows at about a 15% discount to the start of the year,” she says.
“A top pick for global exposure is the Vanguard MSCI International Shares ETF (ASX:VGS), which has been highly traded by Bell Direct clients this year.
“VGS invests in over 1,500 stocks from 20 developed market economies and provides greater exposure to GICS sectors that are poorly represented in Australian industry such as healthcare and communication services.
“Another top pick is the iShares MSCI Emerging Markets ETF (ASX:IEM), which invests in more than 800 stocks from 12 emerging market economies.
“These two ETFs form a great foundation to a global shares portfolio in just two ASX trades.”
Stockhead writer Nadine McGrath tracks the latest moves in the ETF space – follow this link to get an up-to-date read on the latest when it comes to ETFs.