inflation | investment strategy: Do you want to hedge against inflation? Buy farmland, says Maneesh Dangi
You’ve been arguing for the past few months that crude will rise, that inflation will come back, and that it’s time to be cautious. Crude is at $ 85, commodity prices are at an all time high and the government is in denial mode saying inflation is transient. What is happening?
I’m not sure the government is in denial, but to some extent at least global policymakers are a little too engaged, largely due to the fact that over the past two decades, inflation has proven to be very fleeting and especially in the last 10 -12 years it has been very difficult for most policymakers to bring inflation back.
So to that extent I think they are playing with fire but they have been way too patient with this idea of inflation and I have said in the past that it is very likely that they will be wrong and we should discuss why? The conditions are set to ensure that inflation is kept at a sufficiently high level and that policymakers end up surprising the markets somewhat unpleasantly. This is why purely as a risk investor, it makes sense to be somewhat cautious.
There is a level at which you would say that the return of inflation is healthy because it gives back pricing power. Have we gone beyond this healthy mark of inflation?
Absoutely. At least in the developed world, it’s a good thing that inflation is coming back; but remember that this inflation is not just on the demand side. It is also supply driven and what we are experiencing is that in a post-Covid world, two great forces are working somewhat independently on the global economy and creating an inflationary push.
One is that the post-Covid economy is different. It has more demand for goods than the world could produce, and to that extent the goods economy is overwhelmed. The stuff we buy at home, we want a lot more than what we wanted before Covid. So to that extent, there is a mismatch between supply and demand driven more by a higher demand than the supply can meet.
On the service economy side, while the demand is still much lower than the pre-Covid level, but due to the Covis protocols, there have been supply constraints and to this extent, even at a level of lower demand in the service economy, we see demand – supply mismatch leading to shortages. What we are seeing in ports and airports is that even though the number of PLFs is still low, airports are overwhelmed. Mismatches or imbalances between supply and demand create an inflationary impulse. This is not a very welcome thing because it means that at some point we will have to bring demand under control just to ensure that the mismatch between supply and demand does not lead to high inflation expectations and sustained inflation. . So that’s part of the story.
I just want to bring another story, that of energy shortages. This is independent of Covid and what is happening is that many years of underinvestment has resulted in this situation where we cannot do without the old energy sources and given that the demand has dramatically increased. rectified, there are mismatches between demand and supply on the energy side. So these two forces – the mismatch between supply and demand for goods and services and energy shortages – result in a situation that is in fact quite malicious. It is not necessarily something that is good and welcomed by everyone. Unfortunately, there is no solution. Most likely, we will need to bring demand under control at some point to prevent this inflation from becoming generalized and becoming a headache for citizens and policy makers.
What should an investor do because FD yields are low, bonds won’t give good returns, and now stock returns will be capped?
I take a cyclical investing approach. The first phase of the cycle runs from late March 2020 to August 2021. It was reflation trading and that’s when investors made huge tons of equity money on all kinds. of assets at risk. We have now entered an intermediate cycle in which policymakers are starting to restrict the economy. Policymakers like the RBI, the Fed will tell you that they are going to tighten rates and to that extent it doesn’t really matter to the asset market.
Now what’s happening is that because inflation misbehaves to a certain extent and shortages are everywhere, chances are we can quickly go from mid-cycle to end of cycle in 6 to 12 months. Remember that at the end of the cycle on equities and other risky assets, you end up losing money. So while this is not yet my baseline scenario, now is the time to move away from small and mid caps. If you are a risky investor and a compulsive investor, hide in Nifty and large cap mutual funds, if at all, and wait for stocks to be underweight as this is the only way to be overweight in period of reflation.
But if the inflationary impulses systematically surprise the market, the markets will end up being surprised by the political actions as well, which would also mean that they would not like it and that a sell-off will occur at certain intervals. As such, this is a period of insignificant returns in any asset class. Bonds, of course, are absolutely prohibited. Term deposits, bonds are all no-no. Raw materials seem expensive. Stocks are the only place you can hide in mid-cycle but don’t have FOMO, don’t have high expectations of stocks.
The expected returns on equity in real terms will be lower. But we are rapidly or rapidly approaching end-of-cycle symptoms with respect to the business cycle. Be aware that if this happens, we will need to somehow further reduce risk and reduce Nifty or S&P oriented exposures. This is the approach I will take with regard to investors.
I have to say that you are the first of the lot to say it officially, but the point is taken. I understand where the fears emerge. If you are underweight equities, where can you invest? Fixed income securities aren’t yielding, gold hasn’t had the best of the trip like it did in 2020. So where do you park your money? Can’t be sitting on the money?
Fixed income securities are not a place to go, especially duration assets, if you’re worried about inflation. But remember that equity is the longest lasting product. Long bonds are of course of duration and therefore one should hide in a short duration like assets of three months, six months, one year, but here the real returns are in fact negative. Something cannot change significantly, but it could mean a lot if you buy farmland as it provides the best protection against inflation.
Gold and silver have independent cycles, but there might be some steam there. You cannot have significant exposure to gold and silver as a percentage of a portfolio. So, in general, you always have to be in risky assets at least on an equal weight basis, but you have to diversify, it could be real estate, more specifically agricultural land. Part could go to gold and silver then you have to sit on equity mutual funds or equity focused exposures but just know if this is an end cycle. you need to be careful and quickly reduce exposure even to the large cap Nifty at some point.
Buy farmland? Are you sitting on your farmland?
Yes, yes, literally. I am literally on farmland. In fact, it’s also an asset class and over the past two years, especially after 2014, stocks have significantly outperformed farmland. Thus, the entire real estate sector has experienced six, seven years of calm. Farmland in India, compared to any time in the last 15-20 years, especially after 2004, is actually quite cheap compared to financial assets and one can get a rental yield or a farm yield. reasonable.
I’m also sort of very bullish on agricultural prices and as such the agricultural sector in India should be doing very well. So I would advise people to buy farmland if they can, otherwise the first asset you need to buy right now is your own house.