Where to invest in times of inflation

Rising inflation can cloud investment options but some islands of opportunity still exist

Wherever we look, the signals are clear that prices are rising. Most of the conversations among the middle-class and upper-middle-class families are about rising prices denting their budgets. Most people are finding it challenging to balance their budget.

The wholesale price index has been in double digits during the last several months, and the CPI has been hovering around 6%. This is true not only in India but even in the developed world. U.S. inflation is now running at more than 7%, and the response of the central banks has been relatively tepid. In the face of the highest inflation in 40 years, the Federal Reserve has increased short term interest rates by only 0.25%. This seems to have had no impact on inflationary pressures or expectations of inflation one year down.

At the same time, a bloody war has broken out in mainland Europe with Russia invading Ukraine. This has prompted the western world to impose several sanctions on Russia.

This has primarily resulted in elevated prices of oil, gas and other fossil fuels. What has not been much discussed is the impact on food prices. The region is the most prominent wheat and sunflower oil supplier to the global markets. This has led to a spike in international prices of oilseeds.

Metals also impacted

There is also an impact on metal prices, which saw a sudden surge in the price of nickel contracts traded on the London Metal Exchange. The prices of other base metals such as aluminium, copper and steel have more than doubled over the last two years. The war has resulted in a shortage of semiconductor chips which was already impacted by the pandemic predating the war. The zero-COVID policy of the Chinese government has meant that there have been fresh lockdowns in China. This has further affected the global supply chain. This is also contributing in no small measure to rising inflationary pressures across the globe as China remains the factory of the world.

How does this impact India? What should the retail investor with a defensive mindset do in the current scenario? The fact remains that India has been badly affected by this bout of inflationary pressures. The government’s Budget numbers for the financial year, which ended, have been poorly affected on two counts: 1) The much anticipated LIC IPO, which was considered done in the Budget, has been delayed indefinitely. 2) The government has to spend more on fertilizer and fuel subsidies. This will mean more government borrowing, further stoking inflationary pressures.

In the current year, the Budget numbers have assumed a crude price of $75 a barrel and calculated subsidies based on these assumptions. It is now clear these are not tenable and need to be worked upon again.

The rupee has been under pressure and steadily declined for the first three months of the year. This means that we are importing inflation by importing fuels, gold, edible oil, and a key component in our protein basket, dhal.

Also, as the rest of the world tightens its monetary policy, we will have to follow suit or suffer a sharper devaluation of our currency. This will mean we will import more inflation which we can ill afford.

How should one invest in the above scenario?

First, we must remember a quote from John Maynard Keynes from the book The General Theory of Employment, Interest and Money where, in chapter 12, he compares markets with a beauty contest, where judges are rewarded for selecting the most popular among all the faces rather than what they find personally appealing.

The rise in the value of the dollar and exports will mean a surge in the value of companies whose earnings are in dollars. A resurgent and robust American economy has meant IT exports have done well, and the IT index has surged by almost 50% and will continue to do well. Adding the pharma index to this basket might do an investor well.

It is reasonable to expect the price of gold to correct in dollars as interest rates climb in the second half and further increase the sales of gold retailing companies. The commodity itself may provide a buying opportunity.

Further, the rally in the metal index has run its course due to two factors: 1) Further rise in the price of metals will dent demand for steel, copper, and aluminium. 2) A rise in interest rates will mean higher interest payments as most metal companies are highly indebted. Most FMCG companies see a significant correction as volumes contract when these large companies increase costs to offset input inflationary pressures. So during the year, it will be advisable to book profits in metals and move to the FMCG index. This should be done gradually as the market corrects. Selling pressure from foreign institutional investors may allow us to enter the private banking sector at more reasonable valuations.

There is room for a great opportunity, but the reader must remember that ‘markets can remain irrational longer than you can remain solvent’ (John Maynard Keynes). The retail investor has to remain patient and cautious during this year.

(Anand Srinivasan is a consultant and can be reached at anand.s.srinivsan@gmail.com. Sashwath Swaminathan is a research associate at Aionion Investment Services)