Home / Investing 101 / It’s not all bad news as markets retreat on inflation news

It’s not all bad news as markets retreat on inflation news

Energy, gas, fire
Investing 101

Despite the media hype surrounding last week’s US rate hike, interest rates are going up but not as fast or as damaging as everyone thinks. The RBA upped rates for the first time in over 11 years by 25bps to 0.35 percent from 0.10 percent. Roughly a $65 a month increase, on a twenty-five year $500k loan. The US Federal Reserve went a little harder with a 50bps rate hike to restrict inflation from rising past 7 percent. The RBA says its target rate-raising cycle sits between 2.5% and 3%, while the Federal Reserve’s target sits at 2.75% by Christmas.

Let’s say the average loan has a variable rate of 2.92%. Mortgage holders will be looking at a $98 for a $750k loan and $130 for a $1m loan. These are just rough indicators. Getting back to inflation…  although the RBA hasn’t disclosed a formal inflation target, generally an acceptable inflation reading is around the 2.0-2.5 per cent mark. If inflation rises any higher, most fixed interest investments will be delivering negative rates of return.

The US / Australian rate rises were largely expected and weren’t a surprise. Nevertheless, inflation is high and needs to be contained to prevent a recession among other things. There are several factors that caused the price of goods and services to rise such as the massive monetary and fiscal stimulus injected into the economy, supply disruptions that are still slowing production and the global sanctions slapped on Russia preventing them from global trade.


  • Returns measured in real terms are adjusted for inflation. The problems start when the rate of inflation rises above the rate of return and begins to erode savings and purchasing power. For example, an investment that returns 2 per cent before inflation where investment returns 3 per cent. The end result? Inflation will produce a negative return (-1 per cent) when adjusted for inflation.

    Despite all the negativity seen in the press, there is a flip side to this coin. Rising inflation does benefit certain sectors:

    • Banks & Asset managers – In a rising inflation and interest rates environment, bank profitability is connected. When interest rates are raised, banks collect the difference between the interest charged on deposits minus the interest charged on borrowings. But there is a counter argument. By raising rates, mortgage defaults may start to rise, offsetting margin gains. This is a negative for banks.
    • Healthcare – A rise in inflation is usually passed on to the client through higher excess or premiums. This makes a rise in inflation a positive for healthcare companies.
    • Public infrastructure – Unlike other sectors, companies are able to pass on any added inflationary costs to the consumer without cannibalising sales. In the short term, infrastructure companies such as Transurban (ASX:TCL), benefit from higher interest rates.
    • Energy, gas and oil – Rising energy supply and demand have a massive effect on the consumer price index, inflation rises especially in times of war. This is a positive for oil stocks.
    • Gold – Is considered an inflation hedge and has been a safe haven for investors wanting to park their money to avoid inflationary pressures. Gold miners and the commodity are very different beasts.
    • Insurance – In higher inflationary environments, insurance companies tend to increase premiums in line with inflation to fully offset inflationary pressures.
    • Consumer staples – Coles (ASX:COL) and Woolworths (ASX:WOW) are in the consumer staples space and do well during inflation because demand for staples are inelastic and that gives these companies higher pricing power as they are able to increase their prices with inflation better than other industries.”




    Print Article

    Related
    Two ends of the spectrum, as Metcash beats and Carsales buys

    Negative news on the economy eventually becomes good news for stocks, as markets rally on hopes that rate hikes may not be as aggressive as expected. Tech and consumer retailers have gained more than 2 per cent with the healthcare sector the “worst,” adding just 0.8 per cent in the last few trading sessions. In…

    Ishan Dan | 29th Jun 2022 | More
    What is really in the S&P/ASX 200 Index?

    The S&P/ASX 200 Index, often referred to as the ASX 200, is considered to be one of the benchmark Australian indexes. It forms the basis of the fourth and fifth most popular exchange-traded funds on the market and is commonly used by fund managers to measure their relative performance. Most will know what the index…

    Lachlan Buur-Jensen | 29th Jun 2022 | More
    What to watch for in portfolios amid a year of change

    The latter half of 2021 and the majority of 2022 have been among the most challenging periods for investors in several decades. The traditional balanced portfolio, defined as one that holds 40 per cent of assets in government bonds and 60 per cent in indexed equities, is on track for the sixth-worst beginnings to a…

    Drew Meredith | 29th Jun 2022 | More
    Popular
    1
    What does High Conviction mean?
    Ishan Dan | 10th Mar 2021 | More
    2
    Three ASX stocks ripe for a takeover
    Lachlan Buur-Jensen | 23rd Mar 2022 | More
    3
    Battery materials in short supply but valuation is key
    Ishan Dan | 25th Mar 2022 | More
    4
    Behind Brickworks’ (ASX:BKW) record profit
    Jaz Harrison | 25th Mar 2022 | More
    5
    Is JB Hi-Fi the best retailer in Australia?
    Lachlan Buur-Jensen | 25th Mar 2022 | More
    6
    Inside CSL’s big end of year deal
    Lachlan Buur-Jensen | 15th Dec 2021 | More