Did You Know - Summer 2006 Previous Did You Know
Equities can go down as well as up!
Market Comment on Inflation – June 2006
We have recently seen significant volatility in the worldwide stock markets. Many respected pundits have commented that this is not due to one factor alone, but because of a number of factors. Although not exclusive, some have said that this is ‘profit taking’ aligned to significant recent growth and some have also seen ‘bargain hunting’, where equity values have fallen significantly and they feel that bargains are available. Time will tell if these theories are correct.
Many professionals within our industry are concerned about the effects of inflation and how this can affect most monetary values and products, such as income, fund values and even annuity rates!
Inflation in the US has tripled from around 1% in 2003 to just over 3% now (Source: CPI-U, US Bureau of Labor Statistics). Inflation usually increases when economic activity rises - consumers buy more things leading to a rise in demand and a rise in prices = inflation. Sometimes inflation can be self fulfilling - if consumers expect price rises they will demand higher wages. That means that consumers will have more money to spend which will stimulate demand again. Also, companies will have higher wage bills and pass this on in the form of higher prices - a double whammy.
Because higher inflation is associated with higher economic growth, share prices tend to rise with it. But only to a point!
The problem with inflation is that there is a point when companies cannot pass on the cost of price rises to consumers and will have to find other ways of reducing costs to protect profits - such as labour cuts.
Monetary policy is tasked with keeping economic growth reasonable with as full employment as possible - this leads to a content electorate for the government of the day. Most central banks target inflation to achieve this aim - steadying the economy with interest rate rises and falls when inflation moves out of acceptable bounds. Deflation, by the way is a bad thing - just look at the Japanese stock market which didn’t produce gains for well over a decade!
In rising interest rates the central banks make loans more expensive - this reduced demand from consumers because we have less spare cash.
Ben Bernanke became Chairman of the Federal Reserve of the USA (known as the Fed) in February (2006) this year, after what was an unprecedented period of growth and low inflation presided over by Alan Greenspan. Inflation is upsetting companies in the US because it erodes profits and makes longer term investment planning more uncertain - hiring more people is more expensive when inflation is threatening, for example. The media has ‘hyped up’ on this because Bernanke is new to the job and has been a little less aware in his dealings with the media. The jury is still out.
So, rising inflation means more uncertainty about future costs and rising interest rates mean that loans are more expensive and there is less money in consumer’s pockets. This is bad news for companies as it stands.
Economic growth is forecast to slow next year (Source: The Economist, Poll of Economic Forecasters, The Economist, 27th May 2006) – possibly even this year - a result of a slow down in the housing market (loans are more expensive now). So inflation will probably fall too. The Fed has lifted interest rates from 1% in May 2004 to 5% - 16 consecutive rate rises (the fed meets 8 times a year, rather than 12 like the UK System ) now and I think there are more rises to come.
Where does this leave investors? As always, planning is the key to ensure that your expectations are maintained and managed. With the possibility of changes and volatility ahead it is important to keep your financial affairs reviewed.
Churchouse Financial Planning Limited is well placed to help you with your financial planning and the allowances and exemptions available. Please contact us for further information.
For guidance and information purposes only. Please seek Independent financial advice before proceeding with any changes/new contracts. The Financial Services Authority does not regulate taxation advice.
