UK Prime Minister Boris Johnson may have claimed inflation fears are unfounded at his Conservative Party conference, but the fastest price increases in a quarter of a century could indicate otherwise.

Since the start of the year, there have been conflicting views on whether higher inflation presents a transitory blip, or whether consumers and investors should buckle their belts in preparation for a longer-term soar in inflation. The latest reading, for August but released in mid-September, put CPI at 3.2%, up from 2% in July.

The first school of thought, still shared by the vast majority of Bank of England policymakers, is that the four-month breach of its 2% inflation target (which was first recorded in May’s CPI reading)  is essentially unsurprising given the events of the last 18 months. In fact, the consensus view among this party is that inflation will rise even further, hitting 4% by the end of the year before gradually retreating to “normal” levels from 2022 onwards.

Why? Following over a year of lockdowns and restrictions, , it’s hardly shocking prices would be rising as consumers  get back to ‘normal’ life and spend money they were unable to last year.

However, the Bank of England Governor, Andrew Bailey, has started to strike a more hawkish tone, hinting a rate hike could be on the cards before the end of the year if fuel and energy supply problems continue to push prices higher.

The other school of thought has taken a more bearish attitude towards rising inflation since it was first flagged in May.

Their main concern is that, given the sheer level of recent disruption to the UK economy, we could quickly hit levels of hyperinflation not seen since the 1970s.

The BoE’s ex-chief economist, Andy Haldane, who retired in September, voiced his concerns earlier this year. Admittedly, he did not go so far as to suggest we could shortly find ourselves paying for a loaf of bread with a wheelbarrow full of cash. However, he has warned that it is more and more likely the UK’s rate of price rises is likely to follow that of the US, which recently reached 5.3%.

The importance of pricing power

Whichever way you look at it, these eventualities will have consequences for businesses. Inflation always does—it’s an inescapable part of the economic phenomenon.

That’s why an absolutely essential factor for us when picking any stock is how resistant it is to the rising tide of prices. After all, the more “inflation proof” a company is, the more likely it is to thrive regardless of the circumstances.

For us, a key indicator of a stock’s resilience here is its degree of pricing power.

Indeed, the stronger a company’s branding and intellectual property, the more loyal customers are to its products. And the more flexibility a company has to increase its prices in response to inflation without losing customers, the more likely it is to be able to weather any inflation storm and maintain—or even increase—its margins and profitability.

One classic example is Guinness currently owned by British beverage behemoth Diageo.

From just 1.25p in April 1900, a pint of the ‘black stuff' today will set you back, on average, around £7.20. That’s a 57,500% increase in price!

Since the Guinness brand is so strong, the price has consistently been able to outpace inflation throughout history.

On the flipside, televisions are an example of a product that has not been so resilient to inflation over the years. Flat-screen TVs could easily have fetched a price tag north of £10,000 back when they were first introduced by Fujitsu in the mid-nineties. But fast forward to today, and a 55”, top-of-the-range, ultra-HD Samsung TV would set you back only around £480.

The reasons for this are twofold. Firstly, the TV supply chain has become much more efficient, meaning companies can manufacture and sell TVs at a vastly lower price. And secondly, TVs are essentially exactly the same once you take away the branding, with far fewer differentiating features than equivalents like smartphones and tablets.

Essentially, electronics brands have had no other choice than to lower their prices—regardless of inflation.

Positioned for positive returns

We don’t yet know whether inflation will continue to soar or return to normality over the next year and beyond. In fact, that sort of crystal ball gazing is often a thankless task.

What we do know is that whatever happens, companies with pricing power will be in the strongest position. This always has been, and always will be, the case.

With this in mind, we believe that—in this world of extreme uncertainty and rising prices—a portfolio of equities with the ability to increase their profitability dependably offers investors the greatest chance of consistently generating positive returns.

 

Sources:

https://www.reuters.com/world/uk/uks-johnson-says-inflation-fears-are-unfounded-2021-10-05/

https://www.ft.com/content/940e0ba1-485e-4a70-ba29-a966087b6f3b

https://www.thisismoney.co.uk/money/news/article-10062231/Prices-rise-fastest-pace-25-years-Inflation-stalks-UK-economy.html

https://www.thisismoney.co.uk/money/markets/article-10037579/Investors-shrug-BoE-Governors-suggestion-early-rate-hike.html

https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/august2021

https://www.bankofengland.co.uk/speech/2021/june/andy-haldane-speech-at-the-institute-for-government-on-the-changes-in-monetary-policy

https://www.bbc.co.uk/news/business-57670734

https://www.wsj.com/articles/broader-inflation-pressures-begin-to-show-11633339800

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