Why inflation is rising, impact on equity and what central banks are doing: Explained

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July 06, 2021 4:41 PM

Mutual fund Investors should be aware of how the story is playing out in terms of inflation adjusted return being negative or very negligible.

inflation, impact on equity, equity, debt, gold, real estate, good returnsAs an investor, aim for products, essentially equity, which can give you a high real return.

In a response to whether the US economy was headed towards the hyperinflation of the 1970s and early ’80s when inflation peaked above 10%, Federal Reserve Chair Jerome Powell had said that such a scenario is “very, very unlikely.”

The fact is that prices across the board are moving up, not just in the US but also in the Indian economy. The central banks are keeping an eye on the inflationary numbers and expecting them to be transitory rather than turning into runaway inflation.

With inflation, comes the depreciation in the value of currency and a rise in interest rate across geographies could disbalance a lot of other things including the rupee-dollar equation.

As an investor, what matters is the return on the assets including equity, debt , gold and real estate. A disruption cannot be ruled out in these asset classes if inflation crosses the comfortable range set by RBI and other central banks.

Santosh Joseph, Founder and Managing Partner, Germinate Investor Services LLP shares his views with FE online on the reasons behind rising inflation, what central banks globally can possibly do to tame it and what investors may consider in order to keep generating inflation-adjusted returns. Excerpts here.

Should investors be concerned because of rising inflation?

Since the pandemic started early last year, central banks across the world have cut interest rates or have refrained from increasing interest rates so that they can soften the impact of the pandemic on the economy.

This results in two things – on one side of the economy, it creates a a cushion or a soft stand for people to access funds, capital and for people to survive better. But on the other hand, there is a gush of liquidity which actually drives prices of assets and commodities higher.

This inflation is slightly accentuated or could get acute status because there’s been a lot of lockdowns and supply side constraints as far as production is concerned.

Therefore, when you have excess liquidity due to policy actions of low interest rates, and you have less productivity, it leads to more money chasing less number of goods that are produced. Therefore, this is driving the rise in prices and creating an inflationary trend in the intermediate time.

How does it impact equity investment portfolio?

Many of the companies that are listed on the stock exchange are also facing this inflationary trend.  Inflationary trend is nothing but increase of the costs of the input goods.  In this market scenario, not everybody is able to pass on the benefit of price rise hike.

So, therefore, equities earnings will be under stress because of the huge increase in input costs of goods and services because of the inflationary trend, including commodities that we have witnessed in recent few months. Therefore, the earnings will be challenged in an already touchy economic scenario and it may impact equity investments.

What should mutual fund investors do?

Mutual fund Investors should be aware of how the story is playing out in terms of inflation adjusted return being negative or very negligible. They should aim for products, essentially equity, which can give them a real return.

Now even in equity, you have to ensure that the balance is well managed because if you’re not well balanced, and if you are not well weighted or asset allocated, you may not end up making reasonably good returns that you anticipated on a post tax and post inflation adjusted basis.​

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