The first phase of market rotation is often indiscriminate. Investors can just focus on surprise, the potential for further overshoot of expectations and the sudden ability that even bad businesses get to pass on prices. Meanwhile, growth looks less special and investors discount its future more heavily.
But now more serious thought begins. Market opinion is finely balanced between transient inflation and the possibility of it becoming embedded and racing away. Few were investing in the 1960s, so the lessons of history may be forgotten. Investors should think more about the impact of supply bottlenecks, de-globalisation, sustainability and politics. There is potential for much change in the global economy but possibly in a different direction than the exceptional circumstances of the pandemic.
Indeed, the supply restrictions that have triggered sharp price increases may be solved over the next 18 months. It might take longer to address inequalities that have worsened during the pandemic, or to build on the popular mood for a sustainable economy. Disinflationary forces remain, not least within the EU.
It is surely too soon after a great economic shock to bet on supply shortages beating the powerful long term forces of technology and demographics. Indeed, these very shortages and price rises may spur increased capital investment, finally turning round weak productivity growth. And markets should not assume that the US lack of concern on inflation means inaction by all central banks. This year may bring a tightening by the Bank of England ahead of the US Federal Reserve. Brexit has triggered more bottlenecks in the UK economy and its successful vaccination programme has spurred a sharper bounce in the economy than in much of Europe. The key to whether inflation is transient or not will not be found in wage inflation. If the Bank of England acts, the Pound would likely strengthen – cooling the economy a little but favouring domestic stocks over international earnings.
The narrative of inflation and rotation has driven some moves that may prove unsustainable. A more balanced approach to investment style may now be prudent. Within the economic changes of resilience, productivity, capex and sustainability, there is good opportunity for growth businesses.