Interest rates are perhaps the most important factor when it comes to investing. But I think inflation could become increasingly important.
We've seen inflation drift lower and lower in recent years. Indeed, according to the Australian Bureau of Statistics inflation was only 1.6% over the year to June 2019. It was 0% in the March 2019 quarter and 0.6% in the June 2019 quarter.
We always needs to be aware of what's going on with inflation because that affects our 'real' returns. There's no point being pleased with a 5% return if inflation is 5% or higher – you'd be losing purchasing power.
The strength of shares is that they can grow faster than inflation. Keep in mind a 10% investment return with 3% inflation is the same in real returns as a 9% return with 2% inflation, so lower returns are okay if inflation is lower.
Economists are now thinking about two different scenarios. Either the world continues on this path of low inflation for a long time, perhaps forever. Or inflation comes storming back.
A decade ago it was thought that all of the quantitative easing would lead to inflation, but it didn't happen.
It's perhaps not surprising that there's little inflation. Supermarkets like Woolworths Group Ltd (ASX: WOW) and Coles Group Limited (ASX: COL) are seeing constant price decreases. AGL Energy Ltd (ASX: AGL) and others are being told to keep energy costs down. Internet comparison sites and internet shopping keep services & retail prices competitively low. A regular consumer wants prices to be low – which is showing in the inflation figures. Automation, cheap competition from overseas and more power in corporate hands is keeping a lid on costs growing and inflation.
Wages aren't growing, so it's not like consumers could afford higher prices anyway. Or perhaps there'd be higher prices if wages were growing. Either way, inflation is not happening.
But be careful about pinning all of your investment thesis on no inflation. There is talk of more QE from central banks to restart local and global economies, with the RBA being one potential central bank that may be considering it.
But more people are coming around to the idea that governments need to inject some fiscal stimulus to get economies going. Lots more money in the economic system could cause inflation. Higher government deficits and debt could cause higher interest rates.
Foolish takeaway
These are two completely different scenarios, so I think the best way to invest is to make sure you're exposed to some businesses that can benefit from higher inflation, but also to ones that would do well in a low-inflation world. I'm thinking of shares like Rural Funds Group (ASX: RFF), Washington H. Soul Pattinson and Co. Ltd (ASX: SOL), Altium Limited (ASX: ALU) and Magellan Global Trust (ASX: MGG) as good shares to cover most bases.
