Mid Wynd International manager Simon Edelsten (pictured) is not buying the argument that massive government stimulus in response to the coronavirus pandemic will lead to inflation – and even if it does, he warns it will not be the saviour of value investing. 
This week’s UK inflation figures showed a decline in CPI to 0.5 per cent in May, its lowest reading in four years.
However, Man Group portfolio managers Ben Funnell and Teun Draaisma claimed that while the current recession will be deeply deflationary for the next few quarters, the market is underestimating the potential for inflation in the long run.
“Policies such as permanently higher deficits financed by central banks, policies aimed at reducing inequality and less reliance on global supply chains are all likely,” they said.
“Coming out of this recession, eventually, we think these policies are likely to lead to higher average inflation.”
Funnell and Draaisma are not alone – Ruffer Investment Trust has made inflation-linked bonds the biggest position in its portfolio, while Peter Spiller of the Capital Gearing Trust said higher inflation is the only option for governments sitting on public debt levels not seen since World War II.
However, Edelsten is sceptical.
“This is a very deflationary shock,” he began. “There are theories about ways in which you can switch from deflation to inflation. [For example] if the amount of credit which has been destroyed and the velocity of money that has been destroyed in the crunch is outdistanced by all this stimulus.
“But it would be a very brave person at the moment to say that the deflationary crunch that we know is actually happening is going to be exceeded by the money lending, the central bank money printing and the public works being announced.”
Edelsten compared this to 2009 when numerous monetarists warned that quantitative easing was massively inflationary, yet in the end the vast amounts of money printed by central banks barely replaced what had been destroyed.
UK CPI over 20yrs
Source: FE Analytics
There are differences between today and the financial crisis, such as a greater focus on fiscal rather than monetary easing, meaning the stimulus is more likely to reach the man on the street rather than getting tied up in banks’ balance sheets.
Edelsten accepted this is all just theoretical, adding he would not like to make a major call one way or the other in case it is “economic nonsense”.
“We have a couple of gold stocks in the fund in case you get a flip-through, in case it all blows out and in case people get worried that money printing is excessive, and they worry about the value of their savings,” he said.
“We do not expect it to happen, but we are prepared just in case.
“That said, I don’t think it will just be the gold stocks that will work in an inflationary world.”
Inflation tends to be positive overall for stock markets in the long term and many fund managers believe an increase in this measure will be what finally allows value investing to overtake its growth counterpart once more. The theory is that in the sluggish world economy of the past decade or so, companies that deliver growth have been able to command a higher premium. If inflation kicks in, businesses will be able to pass on higher prices to customers and the majority of stock market sectors will rise, eroding the advantage of growth stocks.
But Edelsten called this argument overly simplistic.
“On a stock-by-stock level, if I thought there was going to be plenty of inflation in two years’ time, it would probably make me even more wary of value in the transition through that, because there will be a nasty crash in the middle,” he said.
“I don’t think that cheap stocks with weak balance sheets would look after my capital at all well during that transition, I’m afraid.
“I don’t wish to keep bashing the same drum, but some of the stocks which you wanted to be in in 1971 – not knowing the oil crisis was coming and not knowing inflation was going to go to 25 per cent – were technology stocks, because they were young, cash-generating growth businesses.
“Stocks like Racal did really well during that decade, much better than anything else.”
Edelsten said this means that even if inflation were to ramp up over the next few years, his portfolio would look similar to the way it does today, with quality growth names well placed for this challenge.
“Mid Wynd invests in companies which have very strong market positions and which, therefore, tend to be able to raise prices when there is modest inflation or deflation – for instance, Thermo Fisher, the world leader in scientific equipment, faces little price competition: rather, it competes on quality of product,” the manager finished.
Data from FE Analytics shows Mid Wynd International Investment Trust has made 140.03 per cent since the current management team took charge in May 2014, compared with gains of 93.35 per cent from its MSCI AC World index benchmark and 91.43 per cent from its IT Global sector.
Performance of trust vs sector and index under manager
Source: FE Analytics
The trust is on a premium of 1.56 per cent to net asset value (NAV), compared with 2.93 and 2.08 per cent from its one- and three-year averages.
It is 2 per cent geared and has ongoing charges of 0.66 per cent.