Investors should expect inflation figures in the developed world to surprise on the upside towards the end of the year, according to FE Alpha Manager Martin Walker, who says factors such as a recovering oil price and wage growth will challenge the widely held view of a “global deflationary death spiral”. 
In order to revive their battered and debt-ridden economies following the global financial crisis, major central banks have pursued extraordinary monetary policies such as ultra-low interest rates and quantitative easing (QE) programmes.
One of the main outcomes of these policies was supposed to be the generation of higher inflation, but more than six years on from the crisis and the UK consumer prices index (CPI) has fallen to 0 per cent while the eurozone recently went into deflation.
The consensual argument is that inflation will remain either low or negative for some time to come as, despite the huge injections of liquidity, there is still too much over-capacity in the global economy and debt-levels are still unsustainably high.
On top of that, more short-term factors, such as oil’s 34 per cent fall over the past 12 months, falls in other commodity prices and the possible devaluation of the Chinese renminbi as a result of the country’s slowing economic growth, are expected to weigh developed nations’ CPIs.
Performance of index over 1yr
Source: FE Analytics
However Walker, manager of the five crown-rated Invesco Perpetual UK Growth fund, takes the opposite view.
“It is very hard to push back against deflation when CPI is flat or negative, but I would expect UK and US CPIs to start picking up towards the end of the year and into next year,” Walker (pictured) said.
One of the reasons for that, according to the manager, is because he expects CPIs to start to “anniversary-out” last year’s commodity price falls. However, Walker says the most important factor is that the recent oil price fall is actually inflationary – which is contrary to consensual thinking.
“If people view the oil price falling as a deflationary impact on the global economy, then they are wrong.”
“Yes, in the short term it is disinflationary, but in the long term it’s inflationary. Effectively, you have had a huge helicopter drop of cash on the OECD [Organisation for Economic Co-operation and Development] countries. Oil at $110 has been taxing aggregate demand in developed nations for years and, albeit temporarily, that has been lifted.”
He added: “That will stimulate demand which will tighten capacity.”
In fact, Walker expects the price of oil – which is currently hovering around the $65 a barrel mark – to reach new highs over the next half a decade.
“Over the short term, say a year or two, the oil price could test lows again as there is a lot of inventory building up, but I do strongly believe it will go higher on a five-year view,” he said.
“It does take time to bring production back on and ultimately the cure for low commodity prices is low commodity prices as it stimulates demand and squeezes supply out of the market. That is the reason why there is a reasonable chance that on a five-year view, we may test new highs on the oil price.”
Walker has managed his £1.4bn Invesco Perpetual UK Growth fund since June 2008.
According to FE Analytics, the five-crown rated fund has been a top quartile performer in the IA UK All Companies sector and beaten its FTSE All Share benchmark over three and five years thanks to Walker’s value approach to the market.
Performance of fund versus sector and index over 5yrs
Source: FE Analytics
The fund is also outperforming over the past 12 months, though its returns of 11.99 per cent place it in the sector’s second quartile.
Walker says there are other, more stable factors, which will challenge the “global deflationary death spiral argument”, which has been the major driver of the fixed income market’s strong performance over the past year or so.
Performance of indices since Jan 2014
Source: FE Analytics
Firstly, he expects wage growth in the UK, which the Office for National Statistics shows increased by 1.6 per cent in the three months up to January, will continue to strengthen.
Also, while the Chinese authorities may need to devalue their currency due to slowing growth and the end of the investment-led economic boom in the country, Walker doesn’t see how that would materially affect UK inflation.
“The point that people make about China is a really interesting one, because it has been a push-back against my argument.”
“I looked at the UK CPI to see what sectors could plausibly be impacted by a Chinese devaluation – and it was less than 20 per cent. That would, for example, assume that all the UK’s clothing came out of China – which it doesn’t.”
“The key driver for inflation is services, rather than goods, and we are seeing wage growth inflation in the UK and I think that will start to feed though and cause the CPI to tick-up.”
In an article last week, Walker gave tips on how investors can protect their portfolios from higher inflation and a growth surprise.
These included avoiding bonds at all costs, as yields will inevitably rise, and expensive defensive dividend-paying equities which will be hit as the bond market corrects. He also advocates buying value equity sectors which are exposed to global growth, such as oil companies, miners and banks.