Inflation in the current market
What do we know about the markets right now? They are reaching all-time highs from shares to property, cryptocurrency to NFTs. What we know is that markets are running hot and there is a risk that some investors might get caught out. However, investors also have to be careful because they don’t want to be left waiting on the sideline. The annual inflation rate rose to 1.1% in March 2021 which is well below the average of 4.88% since 1951.
The Reserve Bank of Australia is reluctant to raise the interest rate until 2024 given the impact on the economy. This is because investors worry that government stimulus packages will cause consumer prices to rise. More importantly, these price rises and higher interest rates could lower the profit margins on the companies that they invest in. One of the ley strategies that I use when investing is a long term approach. This reduces the impact of market timing and volatility over time. One of the investment platforms that I use to trade shares and ETFs is Pearler an online investment platform. It allows for automated investing and low brokerage on exchange-traded funds. To learn more have a read of the following Pearler Review.
Are we in an economic bubble?
An economic bubble occurs when there are inconsistent views amongst investors. This can range from predicting an expected price to assessing the future performance of an asset. Shares are generally valued based upon their intrinsic value. Therefore, we could be experiencing an economic bubble if there is a wide gap between the market value of assets and its fair value.
There could be a future market correction to bring the price back in line with its intrinsic value. On the other hand, prices could continue to rise increasing the intrinsic value long term. By the price remaining high over the long term one could argue that we were never experiencing a bubble. Therefore, It is important to consider a range of economic factors. For most, we won’t know that we are in a bubble until it bursts and the prices tumble. So it is best to do your research so you are well-positioned to handle any adverse market reactions.
So what is the best approach to take?
There is one approach that I have found to be effective as an investing strategy. This has been to place an emphasis on long term investing through companies or funds that have strong financials and consistent growth over time. I have at times chosen lower-valued growth stocks with the potential for higher returns. However, this is also riskier so the preference has been to focus on established companies. So the level of inflation may be a concern but does not dictate the decisions I make when investing. Inflation may have a greater impact on those investors that seek to profit from short term trades and trade on market cycles.
There are instances where large swings are created through big companies and institutions taking large trade positions to drive the market. Therefore, by creating a robust and diversified portfolio there is lower risk exposure and concern for market volatility. When investing through shares, property or other asset classes investors can be selective in their investments. This would enable them to hedge the risk of a market crash, mitigating the impact of inflation on their portfolio.
Inflation market impact
Inflation is when there is a decrease in the purchasing power that your money can buy for you. This can be measured by reviewing what a basket of goods costs at different points in time. As the price of the same goods rises over time, the money used to pay for them could be less valuable. This could cause the standard of living to go down if the cost of goods rises faster than wages growth.
There are some assets that are anti-inflation include gold, commodities and even real estate. These assets are able to adjust the price of their good or increase the rent that is charged to tenants. By prices increasing they are slowing down the impact on the inflation on the investment. Inflation rates rising would be beneficial to renters who are saving for a house deposit due to the slowdown in the growth of house prices. They would also be weighing up the cost of continuing to rent vs buying a property. If you are considering shares or property as an investment class, first have a read of shares vs property for further information.
I have included a summary of the pros and cons of the impacts of an increase in inflation on the economy:
Inflation Pros
- Increase in wages growth
- Increase in disposable income
- Earn more interest on the cash in your bank
- Increased bond yields
- Physical assets perform better
- Easier to save for a house deposit for those looking to buy
Inflation Cons
- Less purchasing power through rising price of goods
- Higher cost of trading with businesses
- increase in interest rates to borrow money
- Slows the recovery from a recession
- Higher inflation lower international competitiveness
- Slower growth in house prices for investors
Alternative Investments
There are alternatives to invest within this market including investing in Contract For Difference (CFD) or bonds. However, CFDs are extremely volatile and high-risk investments given lower regulation, lack of liquidity and the requirement to maintain a trading margin. By leveraging the investment, this type of trading could also amplify losses. On the other hand, bonds are seen to be a far safer investment option given their lower risk. This investment class has for the most part been overlooked in the current climate given the low bond yield offered in comparison to shares. To learn more, you can read about how to invest in the share market to build passive income.
Another asset class that has risen to popularity is cryptocurrency. It is difficult to value given there is little information on the value that they provide. However, they have seen a huge growth in 2021 making them one of the hot investments in 2021. Digital assets can be acquired through cryptocurrency investment platforms such as Binance or CoinSpot. Signing up with CoinSpot can even earn you some free Bitcoin! As this is an affiliate link and I would earn a small commission. The other investment alternative would be Non Fungible Tokens (NFT). These are digital investments that provide a unique digital footprint for artwork that can be sold or traded online. As the market grows larger time will tell the impact that inflation has on NFTs and other digital markets.
Summary
Inflation can be both good and bad for the economy and investors so it is important to understand the impact that it may have on different investment classes. Whether we are in an economic bubble no one can accurately predict the timing. So caution is needed and see how the market movements are impacted over time. Whatever strategy you choose, make sure to do your own research and if required consult with a licenced advisor. The information in this article is general in nature and not financial advice, as it does not consider your personal circumstances.
