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"Inflation is not something you necessarily need to worry about right now," starts Jim Leaviss as he addresses a packed room of some 350 delegates at the Morningstar Investment Conference in London. Leaviss contrasts this view with an anecdote about his father, someone, he says, who is stocking up on water and supplies at the mere mention of economic slowdown: “If you’re going to panic, panic early”, he quotes his father.
Inflation is baked into the cake for the UK, Leaviss says. Inflation-linked assets should be good for the rest of the year for UK investors, but the question is what happens in 2012 and beyond. He notes that the VAT increase is still coming through the system and therefore 2012 could be a year of much lower inflation.
But what does all the talk of hyperinflation, inflation and deflation mean for investors? Commodities have shown to be a reasonable hedge, and even cash has done relatively well, despite what one’s instincts might tell you. Inflation-linked bonds give an explicit ‘real’ return—an investor’s not going to get super rich investing in them, but they will get a vehicle that tracks inflation and produces an additional credit return. Corporate bonds, M&G believes, still offer good value; “they look cheap and overcompensate the investor for the risks involved,” Leaviss says. Leaviss’ presentation slides flash up the logos of several well-known companies including Tesco, National Grid, United Utilities and Morgan Stanley, and many more as he talks about the attractiveness of corporate bonds.
“How did you go bankrupt?” “Gradually…and then suddenly” A conversation between two Hemingway characters quoted by Leaviss as he addresses the economic situation of the US. Creating inflation is not good for developed economies, he says, with government outgoings implicitly linked to inflation. The US government, for example, with $14 trillion in debt to service, currently pays an interest rate on that debt of around 2%. Inflation generation could cause this to rise to 4% or 5% and suddenly the US would have to default. This is the same situation for most developed economies, Leaviss says.
“The US is acting like an emerging banana republic,” he says, adding that there was no reason to be surprised when S&P recently downgraded the US outlook. “Defaults will happen,” he adds, noting that countries default all the time and in fact it’s been a remarkably quiet period on the sovereign default front.
In fact, Leaviss believes that to default would be the right thing to do for Ireland, Portugal and Greece. “If I were Ireland I would re-neg on debt and default,” he said, adding that there’s no way these economies will be able to grow their way out of their fiscal situation. If he was the Fed, Leaviss says he would try his hardest to ignore inflation and instead focus on getting the US economy growing and addressing the country’s high unemployment and huge inequalities.
With regards to the UK, we can afford ourselves a slightly “warm and fuzzy feeling” as the Bank of England has learnt from past experiences and now knows it has to borrow for the long term. We’ve not put ourselves in the position where we’re going to end up acting like a banana republic. Leaviss believes the UK should maintain its AAA rating for a few more years, but he suspects the US may lose it sooner.
Reiterating what this means for investors, Leaviss highlights his preference for corporate bonds. He predicts that the current environment of upgrades of corporates and downgrades of banks will continue.
