CAPITAL spending is the dark horse in the debate on inflation, says Pendal’s head of equities Ashley Pittard.
Wage and transport costs and consumer spending tend to grab the headlines. But capital investment by business, with long lead times, can provide a significant, sustainable fillip to prices.
“If we start seeing capital expenditure re-rating year on year, that will solidify inflation coming through,” says Ashley Pittard, head of Pendal’s Global Equities boutique.
“In the first quarter of this year capex was mixed in the United States. But in the second quarter it was the strongest capex since 2004.”
The prospect of inflation remains the big question in financial markets: is it transitory or structural?
Central banks around the world have mostly argued it is transitory. But in recent weeks the US Federal Reserve, the European Central Bank and the Reserve Bank of Australia, among others, have spoken of winding back bond purchase programs.
If the pick-up in capital spending continues, higher prices are much more likely to be here to stay.
Businesses, particularly in Europe and North America, are willing to invest because of the earnings boosts they’ve experienced in the first half of this year — and based on improved profit margins.
“Earnings growth is up almost 100 per cent across the S&P500 for the June quarter, but sales growth was up only 27 per cent,” Pittard says.
“In Europe, the sales growth was 28 per cent, which is very similar, but the earnings growth was 243 per cent.”
Europe’s outperformance partly reflects the mix of sectors with energies and financials higher contributors to European bourses. Those sectors have done very well with commodity prices rising, and relatively few bad debts to deal with for the banks.
Also, Europe started from a lower base and had more scope to climb, Pittard says.
“Earnings have been strong year-on-year and against 2019. But companies are also getting massive margin expansion and in some cases the highest margins ever,” he says. “This is encouraging capital spending which is adding to inflation.”
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Price rises are already coming through with US inflation up 7.8 per cent in July, German inflation at 3.4 per cent (the highest rate since 2008) and Spain at 3.3 per cent.
“You are seeing Europe getting inflation in the mid threes. You have the US with inflation well above 5 per cent,” Pittard says.
For businesses, when borrowing is so cheap, and earnings are rising, they pay down their debt quicker and can invest more, he says.
If the investment is productive it can eventually reduce inflation. But in the short-to-medium term it will put pressure on prices.
Capital spending adds another piece of the argument that inflation is more than transitory.
“There is no doubt it is a timing issue before transitory inflation becomes structural inflation,” Pittard says.
Ashley Pittard leads Pendal’s Global Equities investment boutique. He is responsible for setting the strategy, processes and risk management for the boutique and its funds including Pendal Concentrated Global Share (COGS) Fund.
Ashley has more than 24 years of finance experience, including roles in petroleum economics, global energy investment analysis and 20 years as a global equities fund manager.
Pendal COGS Fund is an actively managed, concentrated portfolio of global shares diversified across a broad range of global sharemarkets.
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