Inflation is Not Bad for Shareholders

THE WEEK: Investors may be confused by the contradictory economic data this week, says Rodney Hobson, but the good news is that employment has risen yet again

Rodney Hobson 18 July, 2014 | 11:12AM
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No wonder economists can’t agree on anything. Economic data tends to be contradictory, and so it was this week.

First we had inflation figures that, at 1.9%, were higher than expected, although the figure is still, just, below the 2% target. Inflation over the past few years has had a nasty habit of coming out higher than expected but we seemed to have put that behind us when the rate finally dropped below 2%.  Now the phenomenon is back to taunt those who talk about deflation at the least opportunity.

Inflation in itself is not bad for shareholders. On the contrary, it makes sense to stick with an investment that keeps pace with or beats inflation. What is worrying is that inflation continues to squeeze incomes quite severely, which means consumers have less cash to fuel the economy. 

However, the good news is that employment has risen yet again, so more people are earning and therefore spending. The outlook for the UK economy remains on the whole bullish.

That optimism has translated into a continued strengthening of the pound, an event that tends to cause panic among economists. We should remember that sterling is still below its pre-crisis level and that a strong pound holds down fuel prices, which have a knock-on effect on inflation and costs.

In the long run a strong currency is good for the economy. The short term effect, though, is to reduce the income from abroad of companies with a global presence. Some international players will be reporting lower than expected earnings this year.

A rising pound also makes investing in gold less attractive, as it effectively depresses the   value of gold as translated into sterling. The gold price has spiked after the shooting down of a Malaysian aircraft over the Ukraine but I am struck by how the precious metal has remained depressed over several months despite tensions with Russia.

 I’m not convinced that it will go much higher unless there is a serious escalation, which President Putin has shied away from in the face of sanctions.

Russian Roulette for BP Shareholders

Those who buy shares in BP (BP.) are playing Russian roulette. BP’s partner Rosneft is a prime target for sanctions. While I don’t expect a long term impact on the gold price, I do see a continuing drag on BP’s share price. Despite the latest fall, the shares are too expensive given the risks.

Tide of Debt

If investing was a joking matter, I would start this paragraph with “Do you want the good news or the bad news first”. 

Severn Trent (SVT) is far from being a laughing stock and the good news is that the dividend is being raised by more than inflation. The bad news is that debt levels are higher at a time when economists are debating how soon and how quickly interest rates will rise.

It’s not a bad investment and every portfolio should have at least one utility but I can’t help feeling that Severn Trent has got its priorities wrong and that a small increase in the dividend combined with paying down debt would be better at this stage.

Tobacco Stocks Smoking Hot

Investors took fright when Imperial Tobacco (IMT), in which I own shares, decided to drop its share buybacks and instead spend £4.2 billion buying brands in America. One should not worry at all that Imps will no longer support the share price, as buy-backs are of dubious merit, but a massive spending spree is admittedly another matter.

This is not, however, a case of reckless management splurging out shareholders’ money on a wild spree that leads inevitably to paying over the odds. Imps is snapping up brands that are becoming available because two industry giants, Reynolds American (RAI) and Lorillard (LO), are merging and must sell in order to satisfy competition fears.

Thus IMT was in a good bargaining position and the brands include well-known names such as Winston, Kool and Salem plus Lorillard’s e-cigarette business. Lorrilard’s former chief executive is returning to run Imps’ American business.

I think this is a positive move and IMT is using cash saved from suspending share buybacks to pay down debt, which is very sensible. Also the dividend will be increased by at least 10% this year. Well worth holding.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
BP PLC389.15 GBX-1.26Rating
Imperial Brands PLC1,724.50 GBX-1.15Rating
Severn Trent PLC2,918.00 GBX0.10

About Author

Rodney Hobson

Rodney Hobson  is a columnist for Morningstar.co.uk and author of several investing books, including The Dividend Investor and How to Build a Share Portfolio.