Prices keep rising and rising. This is felt especially at the petrol station, but also with the daily shopping. Our Chief Economist Philipp Dobbert explains why investing in global ETF portfolios helps protect wealth against inflation.
In March, consumer prices in Germany rose by 7.3 percent. Inflation seems to be climbing relentlessly. Why is that?
The high inflation rate is still mainly attributable to energy prices. The initial trigger was the surge in demand after the first waves of coronavirus. Now it is the war in Ukraine that is intensifying the trend. Excluding energy, consumer prices in Germany rose far less strongly compared with the same month a year earlier, namely by 3.6 percent. However, there are bottlenecks and supply chain problems not only with energy but also with other raw materials and intermediate products. When demand exceeds supply, that drives up prices. Here, the effects of the coronavirus pandemic are still showing – currently, for instance, through the spread of the Omicron variant in China. On top of that come the consequences of war and sanctions.
Anyone investing money over the long term wants their wealth to grow, or at least to keep pace with inflation. How can you do that in this environment?
Certainly not with interest-dependent forms of investment such as a savings account or an instant-access account. But that is nothing new. Right now the truth is simply being shown under a magnifying glass: with interest rates near zero, interest products deliver – after inflation – a real loss of wealth. That remains the case even when the inflation rate falls back to two percent. Real returns come from the equity market, with a long-term and systematic investment.
So why does the equity market protect against inflation?
Shares are not a magic bullet. There is no guarantee that equity returns will always be above the monthly inflation rates. It is about the long-term average. With shares, you invest in the economy’s value creation, one of the most reliable forms of inflation protection. When the price level rises, this is reflected sooner or later in revenues and profits – not of every single company, but of the broader market. Through quirion’s ETF portfolios, you participate in this development at all times – even when the broader economy reaches new price levels.
But equity investments have a different risk profile than interest products…
To optimise the balance between return and risk, you have to diversify as broadly as possible – as we do in our globally positioned ETF portfolios. To cushion the fluctuations of the equity market, we use bonds. Their share of the portfolio varies with your personal risk appetite. This strategy also works at current bond prices – even, that is, when bonds slightly reduce the return on balance.
Are there other forms of investment that protect wealth against inflation – such as gold or special inflation-indexed bonds?
There is no magic formula. As inflation protection, gold has sometimes worked and sometimes not. In any case, gold makes no systematic contribution to value creation in the economy. Unlike with shares, there is therefore no economic reason for its price to rise over the long term. Inflation-indexed bonds, in turn, are complex financial products. They resemble a bet more than an insurance policy. When you buy such a product, you are betting on very specific inflation expectations and how they will develop in the future – again a matter of speculation.
Even if this too is speculation: how do you assess the further development of inflation?
A stronger price shock in energy commodities usually stays confined, at first, largely to that sector. If energy prices fall again quickly, not much happens. But the longer energy costs remain at a high level, the broader the trend becomes, spreading to more and more goods and services. A simple example: suppose you run a landscaping business. You always drive out to your customers in a van. You won’t automatically change your price list if fuel is more expensive for a while. But if prices keep rising and then fertiliser also becomes more expensive, it eats into your balance sheet. So at some point you will raise your prices. That is how it is in many lines of business. The longer important raw materials stay expensive, the more strongly this radiates out into further sectors of the economy.
What about the central banks – don’t they have to act now?
It is important to understand that central banks have no way of influencing prices directly. Interest rate hikes, too, do this only indirectly: they dampen demand across the economy because investments become more expensive. But this instrument has to be used very carefully if you don’t want to choke off the economy. At the moment, the ECB is chiefly concerned with not letting inflation expectations overshoot. You could clearly see this in its communication. Companies and consumers must retain their general confidence in price stability. At some point prices will settle again. But no one knows when that will be.
