The Inflation genie is well and truly out of the bottle

The headline inflation reading of 5.1 per cent affects consumers and investors. Picture: AFP

There should be no surprise in the headline inflation reading of 5.1 per cent. The only surprise is that it has taken investors so long to accept the genie is out of the bottle – not just on Wall Street – but inside our own market.

The warnings have been persistent across the economy: in fact it is almost exactly a year since Jack Troung – the former CEO at building materials group James Hardie – broke ranks with his ASX 200 peers and proclaimed loudly that inflation had arrived.

But it took another 12 months of accumulating evidence before the ultimate confirmation arrived in the shape of the latest Consumer Price Index figures.

For consumers, extended and rising inflation means higher prices and effectively lower salaries because the spending power of every dollar declines.

But for investors it is a deeply significant change – a change in the nature of shares that will win in the months ahead, a change to the benefits of cash savings, and a change to the real income that might be received from existing investments.

For pensioners or retired self-funded investors the change is most significant. Older Australians on a fixed pension will likely discover it a long time between income rises if they are waiting for indexation of pensions payments.

Meanwhile, for self-funded retirees the goalposts have also moved – you still have to take risks, it’s just that the rewards will now become harder to find.

Importantly, cash deposits which have been a loss-making proposition will now take on a different aspect. Economists tell us that this inflation breakout could move official rates higher by 1 per cent inside a year. In the bond markets, the 10-year government bond yield is signalling 3 per cent.

It is clear the cash deposit rate – starting from a very low base – will start to lift in the months ahead. If – and only if – inflation settles lower, then cash in the bank could again become a feasible alternative to money “at risk” in the markets.

The outlook for shares also changes: just now the dividend yield on the wider Australian sharemarket is back above 4 per cent. Coupled with franking it means a shrewd share investor can have a solid inflation-hedged income based on local blue chip shares.

The best choice of all will be shares where the dividend yield is not just significant but expected to improve as we move further into the current cycle. This can include bellwether stocks such as the banks, supermarkets and – despite their volatility – the bigger mining companies.

But headwinds will only worsen against stocks that have no profits or unreliable profit patterns – the backlash against growth stocks is far from over as we can see on the US market over the last month where Netflix, Alphabet (Google) and even Tesla have been hit.

The same can be seen on the ASX where it’s not just Afterpay and its peers that have dropped this year but also the nearest proxies the local market can produce for overseas tech leaders. On the ASX this would include NextDC and Xero, two stocks which have fallen sharply this year – Xero is down 35 per cent against just 4 per cent for the ASX 200.

Alongside blue chip shares with rising dividends the other two traditional investor defences against inflation have been property and gold.

In our residential property market, yields – in the form of rental yields at just over 3 per cent – remain very modest, but the latest data showed an uptick in yields due to the double impact of lower dwelling prices and a severe shortage of rental property.

You might reasonably expect gold to have been running higher over the last few months. Unfortunately, there is no sure thing in a market where rates are set to lift for the first time in 12 years, inflation readings are competing with the 1970s and the sharemarket is showing signals – on Wall Street at least – of a bear market.

Gold prices actually declined in recent weeks. Despite lofty projections of the metal vaulting the $US2000 mark, it has yet to manage that feat. The explanation is partially linked with rising rates – the theory is that a better yield from cash will take potential investment money away from gold. That, however, is just a theory – the yellow metal has proved to be a powerful inflation hedge in the past and it may do so again.