The monster under my bed
It is lurking down there; it's going to come out any minute. When I look underneath the bed, I see nothing. However as soon as I'm back under my covers, I can feel its presence. There is another spooky spirt in the room too! I'm quite sure it's there and no, not the monster under my bed. It is the specter of inflation under the surface.
Economists and macro analysts study the economic figures and rack their brains. Is it coming or isn't it coming? Who can tell? Shareholders are also looking anxiously to the future. But does that make sense and is there a case for this?
<< I have been through some terrible things in my life, some of which actually happened. >>
Mark Twain sums up the attitude of so many investors. A far better way to make ourselves invulnerable is to wear a red cape and a big "S" on our chest as we would become ourselves “Super Shareholders”.
Become Superman and Supergirl of the markets
What is the best way to do this? Just as Superman has to find a cure for the kryptonite (1) that could weaken him, we need a cure for inflation. If it doesn't come, we win. It comes in a small dose, we win. It comes with vehemence, we still win, just with a little less and the effects take a little longer.
You know that malicious compliment, “Your clothes are timeless. They've never been fashionable.” It is much the same with inflation. The numbers calculated are timeless; they don't apply to anyone. "Housing, water, energy" is the weightiest part of the basket (in the case of Austria). That may be true for most, but not for all.
Important for people - who want to and can invest - is asset price inflation. If the prices of real estate, stocks, bonds, gold, art and the like rise sharply, this has a much stronger impact on us than the ever-cheaper computer or the stable milk price.
Money is abolished
This asset price inflation has been significant in recent years and the COVID-19 crisis is doing its part to fuel prices as large support packages are being put together around the globe, and central banks are keeping the money spigot open. The new U.S. President Joe Biden is leading the way with a currently announced aid package of 1.9 trillion U.S. dollars.
In Vienna, when someone is just throwing money around, people like to talk about “money being abolished.” That hangs a bit in the collective back of the head. There's a sense that it can't be good for the purchasing power of the euro and the dollar if enormous money packages are handed out and debt rises sharply.
Who knows what the future holds
Instead of racking one's brains about what's coming, one should ask oneself, what can I do now? The standard answer: invest in real assets. However, not at any price. The best asset, bought at too high a price, will be a bad investment.
Equities remain an important part of the investment universe. Can you still get in, should you already get out? Unfortunately, I do not have an answer to this question. May I suggest a different approach? One should always be invested in equities to the extent that you can financially support. Market timing - getting out of the market and into the market in time - does not work. You can get lucky, like running a red light through an intersection. Yet, that does not make it wise.
I agree with Irving Kahn (2), who said:
<< There is always something to do. You just need to look harder, be creative, and be a little flexible. >>
The statement: “Inflation is good for stocks.” is not true. It depends on the business model. Pricing power, so to speak, is the remedy for the inflation kryptonite.
When inflation surges, the wheat is separated from the chaff. Who can really pass on the price increases in raw materials, energy, labor costs and capital investments to customers, and who suffers from margin pressure? The market, in its infinite wisdom, recognizes which companies can and which cannot. The valuations are accordingly.
Strong brand or indispensable
Strong brands, for example, have pricing power, i.e. the ability to raise prices without a major loss of sales. Just think of the iPhone, which makes more profit than all other smartphones combined. Even though its sales only account for a third of the total market. Or the family that pays 99 euros per year for the "Microsoft 365 Family" package. Will they cancel Word, Excel, PowerPoint and Outlook if the price is raised to 120 euros? Probably not. Here, the hassle of switching products lends protection (“switching costs”).
Capital-intensive business models are hit particularly hard by high inflation. The depreciated investments have to be renewed at some point and then become much more expensive due to inflation. Not a pretty scenario.
Ideal business models are those with products and services that are important to their customers, but financially represent only a small part of the total budget. This can be the design of a small chip in a smartphone or a mandatory spare part in a large machine.
In addition, companies in the defensive sectors of consumer goods and health care are good candidates. But beware, when inflation is high, people switch to cheaper copycats. However, this is less likely to happen for example with innovative cancer drugs.
Pricing power and the rescue in need
Finally, here is another attempt to explain pricing power. Please imagine the following situation: You are standing in your front door in evening dress or tails in pouring rain and have to be at the State Opera in half an hour. Anna Netrebko has invited you to her box. Your cab driver now has real pricing power. However, this power is limited due to regulation - something that can be both a curse and a blessing in business models.
Or another scenario: In ten minutes, you'll be awarded the “Decoration of Honor for Services to the Republic of Austria” (the highest national honor) and you've just poured a glass of red wine over your spotless white shirt. Whoever gets you a fresh shirt in the next nine minutes can charge almost any price for it. Pricing power!
You shall experience both and hopefully soon. Not the rain and the stain. Rather, I wish you a medal for overcoming the crisis and a glittering ball night.
(1) Kryptonite is a fictional material and the weak point of the comic character Superman. Meanwhile, also an older gentleman - if he ages. In 1938, he appeared for the first time.
(2) Irving Kahn was an interesting personality. He died in 2015 at the age of 109. At 73, he founded Kahn Brothers Group, Inc. with his two sons. Wonderful, I still have options!
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