2021: How to prepare for the return of inflation

Inflation should make a big comeback in 2021: equities, gold, euro, dollar, emerging markets… Which asset classes should you favor to prepare your savings?

We should see in 2021 a return to a certain “normalization” of economic activity. Corporate profits should thus recover after a complicated year 2020 when central banks bought without counting the debts of the States which have dealt with the crisis with support measures of an exceptional scale.

Between mid-March and the end of December, the Fed’s balance sheet fell from $ 4,700 to $ 7,400 billion. Before the 2008 crisis, it was less than $ 1,000 billion. As for the ECB, the institution holds € 2,800 billion in government securities, or nearly a third of European public debt. For France, the increase in debt is € 400 billion between 2019 and 2021.

The level of debt is so high that neither taxes nor growth will be enough to pay it off.

How will governments do then?

The reimbursement will go through inflation, which was the case after the Second World War. Irony of history, US public debt returned to post-war levels, exceeding 100% of GDP:

Source: JP AM, CBO

The budget deficit creates inflation

When we talk about inflation, we mean rising prices. However, we forget that the first source of inflation is the creation of money used to finance the budget deficit. As shown in the graph below, the quantity of money in circulation in the United States jumped dramatically in 2020 (notably explaining the rise of gold which has played its role as a store of value).

Inflation of stock prices

However, if there is more and more money available to buy a limited number of assets, the price of those assets should go up. This is what we see below: the valuations of companies in the S&P 500 (US stock index) have soared.

Consumer price inflation

Consumer price inflation in the Eurozone is currently close to zero, but it has already rebounded to 2% in the United States, as can be seen below:

In addition, there is a correlation between the growth of the money supply M2 and the inflation of consumer prices, which suggests that the level of inflation today is underestimated and that it should be at a higher level.

Inflation, bad news for savers

So far, the Fed’s liquidity has caused stocks to rise, but not inflation expectations.

In order to better understand this phenomenon, we must start from the quantitative equation of money which is written MV = PT, where M denotes the quantity of money, V its speed of circulation (velocity), T the volume of transactions and P the general price level. The speed of money circulation is historically low … but the household savings rate is historically high.

With a “normalization” of the economy in the second half of 2021, it is likely that consumption will accelerate and, with it, the velocity of the currency, which should lead to a rise in prices, and therefore inflation. .

Inflation is therefore good news for the State… but bad news for the saver.

Higher inflation in a context of low interest rates is good news for the government because it is the most effective way to write off public debt. On the other hand, it is bad news for the saver because inflation negatively affects the value of the currency.

What is scarce is expensive, but what can be obtained with a single click of the mouse (the central bank printing money) is not worth much.

Where to invest your savings?

Over the next few years, inflation is expected to increase, while rates are unlikely to rise significantly. Those who have their savings in cash and in bonds will lose money. The only way to preserve capital is to invest in companies that have the capacity to raise their prices (” pricing power ”) And with high returns on capital employed, strong balance sheets and cash flows stable.

In terms of style, we should not expect a further rise in stock market multiples of so-called “growth” stocks as in the past (fueled by the fall in rates which seems to have reached a plateau).

It is relevant to increase its weighting to the values ​​known as ” value And quality cyclicals whose performance will be driven by earnings growth, because it is important to remember that long-term earnings growth of companies constitutes the bulk of stock market performance.

In terms of geographic areas, emerging stocks are at their lowest (see below), as are emerging currencies – which may constitute an additional source of gain. China will emerge strengthened by the epidemic and become an even greater burden: China’s economy accounted for 66% of the US economy in 2019 and is expected to represent nearly 80% by 2021.

August 15, 2021 will mark the 50th anniversary of the end of the convertibility of the dollar into gold, a prelude to a continued depreciation of the dollar and an inflationary surge (aggravated by the oil shocks).

The surge in public debts and money creation in 2020 is therefore likely to thwart the consensus view of market participants on low inflation.

We are thus entering a decade where you will definitely have to reckon with the return of inflation and adapt your investment strategy efficiently because, in an inflationary period, doing nothing can be expensive.

We must invest in order not to get poorer.

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