Seeking shelter from inflation

Seeking shelter from inflation | Daily Tribune

The situation is not quite unlike the Ukraine-Russia war where a global power has decided to use military force against a smaller nation that resulted in volatility in energy prices.

Regardless of the differences, the Ukraine-Russia war offers a bitter lesson for the whole world — prolonged warfare results in an inflationary environment that takes a while to exit and in a painful manner.

Using that as the case study, the biggest question at the start of the Ukraine-Russia war and is also reasonably asked today is how long the conflict will last.

As then, the Iran conflict is now turning from days to weeks and if we assume boots on the ground will be necessary, the probability of this quagmire extending to months increases. That is why we cannot put away the inflation playbook just yet.

If you look at inflation from an investor’s perspective, the key element to consider is pricing power or, as Warren Buffet calls it, a company’s economic goodwill. If a company has a good product or service or there is scarcity, it will be able to pass on increases in costs to its customers and recover them over time faster than those that do not possess economic goodwill.

There may be some pullback in demand as prices rise but, over time, customers come back.

How can you tell if a company has significant economic goodwill? The company’s market share is a good indicator. In some Philippine consumer segments like beer and canned tuna, market share can be dominated by one or two companies. Other industries may have a more fragmented and competitive nature, which requires more effort to build pricing power that lasts.

In such industries or market segments, investors need to conduct a higher level of due diligence and investigate whether customers love the product or brand so much that they are willing to shell out the extra peso to buy it. Without this goodwill, the consumer’s decision will only be based on price and competing on that will eat into profits eventually.

Economic goodwill is natural in some industries such as utilities, e.g., electricity and water.

Because of the regulatory nature of utilities, its pricing power comes from the scarcity of the services. While returns are capped by regulation, the stability of pricing power eventually benefits investors in terms of dividends.

Banks are important to have in a portfolio but they have certain nuances with regard to inflation.

In high inflationary environments, interest rates are expected to rise, which helps bolster banks’ interest income. But higher interest rates hurt borrowers, and this may lead to some deterioration in their ability to pay the interest and principal on their bank loans. We see this in some property companies that are still coping with the loss of demand since inflation and rates spiked in recent years.

Remember though that when inflation rises, purchasing power declines. The peso you earn today will buy fewer products tomorrow. Keeping too much cash in the bank as savings can also be counterproductive in an inflationary environment.

A powerful investment whether in a high inflationary environment or not would be an investment in people — including yourself. Investing in health and continuing education as better health and diversification of skills and social networks will enable you to beat inflation with either a higher salary or opportunities in industries that have or are gaining economic goodwill.