First Base
Here we are, at the midway point of 2021 and I hope you all have something to cheer about no matter how small it may be. There has been a number of trend shifts versus this time last year and perhaps the most significant is the macro backdrop. Inflation to be specific.
Although my long term plan is pretty much exactly the same as even 4 years ago (increase income bags and aggressively accumulate assets), sometimes it pays to do some short term tinkering to steady the course.
In this blog, I’m going to think aloud in regards to the following:
The Current Inflation Debate
The Impact of Inflation
The Resultant Big Picture
Defensive Plays
Attacking Plays
The Current Inflation Debate
Central banks, particularly in the US have been describing the resurgence of inflation in recent months as transitory in nature given the snapback economic recovery from last year’s covid-hit low base. As such, they look to drag out the normalisation of monetary policy i.e. raising interest rates and putting winding down bond buying.
Some debate topics:
will inflation continue to accelerate or decelerate?
is inflation driven by freedom spending and high savings glut?
is inflation driven by economic normalisation?
is inflation driven by input costs (supply chain constraints)?
Critics to delayed central bank responses see the inflation uptick as more persistent in nature due to structural labour market shifts and things of that nature. Therefore, they call for action much sooner. I’ll leave it there for now but check out here for some colour about the debate in question.
The Impact of Inflation
We can probably all relate to everything feeling more expensive since reopening. The brunches, groceries, holidays to say the least. Not to mention, inflation linked expenses which have a much lower payment frequency - mobile phone contracts are a great example of this. Many bills tend to be inflation linked as detailed in the small print. All else equal, hopefully natural yearly salary adjustments offset this but wage growth in some industries are stagnant.
Beyond that, purchasing power of cash flow is eroded too. Another derivative impact is student loan interest rate calculations as these are derived from inflation rates. If interest rates or simply the future expectations are adjusted upwards then the housing market as well as some mortgage repayments will be impacted.
Overall, inflation just makes life feel more expensive if completely nakedly exposed to it. I’ve swallowed that pill a long time ago and just learn to deal with it.
I’m running a flat emergency fund position currently, so my margin for error in a high inflation environment is pretty low. I usually make pretty big bets on myself to try and maximise the impact of my decisions. Let’s see how it goes over the rest of the year.
Finally, while financial markets deliberate how inflation will change the interest rate outlook, most asset classes will continue to be driven largely by this rhetoric at least in the short term. Implications on valuations of equities, present value of cash-flows from yield based assets and all the rest.
The Resultant Big Picture
In regards to the long term plan to increase income bags and aggressively accumulate assets, nothing has changed. This will be entirely dictated by age first and circumstance second. It’s a proven playbook in a capitalist environment and short-mid term market dynamics should not sway this.
However, the life cost basis is heavily exposed to inflation so adjustments and reiterations could be necessary. The main focus for me is to:
maintain investing rate
prioritise sound capital allocation
enjoy simple life pleasures when budget disappears!
Defensive Plays
In regards to sound capital allocation, paying down expensive debt looks attractive right now. My passive contributions are buying markets at all time highs while my active contributions have made their beds and actually accumulating cash due to no high conviction ideas. Couple this with the fact that the hurdle rate for clearing expensive debt like student loan vs investing is pretty high for me now.
As such, a good way for me to defend right now would be to re-route free cashflow towards debt repayments. Will explore this option over the next couple of weeks. The idea is that if cleared faster than the standard rate, this would free up incoming cash flow when the market is at more attractive levels / more convicted about certain ideas.
Attacking Plays
The other side of the coin is the attacking plays which I will discuss more on the premium channel and upcoming What’s in Your Portfolio session. In short though, it involves yet more capital allocation in regards to decisions about sectors, company life-cycle, crypto and emerging theses.
Until next time,
Peace!
[If you’re a corporate person don’t forget to check out Trad-Fi to DeFi]