Weekly View - Stepping on the gas
The Federal Open Market Committee meets this week. While nothing much concrete is expected, observers will be looking for hints on when an announcement on tapering will be made (probably in November, in our view). They will also be looking at the updated ‘dot plot’, which gives insight into where Fed officials think interest rates will go. The update could indicate increasing restiveness in the Fed ranks about consumer inflation and red-hot asset prices. The consumer price index (CPI) for August actually showed a small decline in the headline and core inflation numbers in the US. But a closer look showed price pressures broadening out to sectors like food and rent even as they cool in some others. Significantly, consumer inflation expectations continue to rise and risk keeping CPI well above target for longer than the Fed anticipates. This is one reason why in fixed income, we remain short duration and prefer to take credit and spread risk than duration risk. And with higher producer prices biting into corporate margins, that is why we look at companies with pricing power in equities.
Monetary policy meetings are also taking place this week in Scandinavia, Japan and the UK. In the latter, the Bank of England finds itself dealing with the highest annual increase in consumer prices in nine years (3.2% year on year, well above the Bank’s 2% target). Any hawkish signal this week would likely give sterling at least a temporary boost and push gilt yields higher. But all of Europe is facing inflation pressure, helped by a serious increase in gas prices. This has led to increasing government intervention. For example, the Spanish government has introduced price caps on consumers’ gas bills and has decided to tax energy firms’ “excess profits”, thus hurting the shares of local utility firms. With companies and countries showing differing capacities to face price tensions that could last for a while, our ‘who pays the bill?’ investment theme appears more valid than ever. But do current tensions mean we believe we are approaching stagflation, marked by high inflation and low growth? We think the risk is low: robust retail sales in the US and manufacturing data in Europe show that growth, while slowing, should remain relatively resilient.
Finally, another of the investment themes we outlined at the start of the year was dividend growers. Dividends and (especially in the US) share buybacks have been picking up, and we think could constitute a bigger share of total returns as earnings growth slows. The relevance of this theme was brought home last week when Microsoft announced a 11% increase in its quarterly dividend from the previous quarter and a 50% increase in buybacks.