After a long period of relatively low inflation, prices are starting to rise once again. The latest figures show prices rose by 1.8% in the year to January, closer to the 2% level which is the Bank of England’s long term target. The Bank expects inflation to rise to around 2.7% by the end of the year and, as a result, is facing calls to raise interest rates in anticipation of the change.
So what might this all mean for investors? When inflation rises, assets with fixed income such as bonds, become far less attractive unless they are index-linked. It can also be a problem for investors in shares for a number of reasons.
In general terms, inflation reduces company earnings because it increases the costs for many businesses. The weakness of Sterling since the EU Referendum is having precisely that effect on many companies who have to import the raw materials with which they make their products, or finished products which they sell on to their customers.
Rising inflation can also, as mentioned above, lead to a rise in the base rate which then often causes banks to raise the rates on their loans to businesses. In turn that can hinder business growth which affects the country’s economic growth.
These factors are worth taking into account when reviewing portfolios and considering how best to deploy any unused ISA allowance. For investors who rely on the income from their portfolios to boost their regular income, inflation is especially significant and we have some suggestions for this group.
While a good dividend yield is important, investors should also focus on companies with consistently strong cash flow and which have a good long term track record of raising dividends. The larger they are, and the more diverse their sources of income across countries and sectors, the better for investors as that should help to smooth out any problems in any one market.
Given that much of the impetus for inflation at the moment is from the weak pound pushing up import prices rather than economic growth, we would suggest it is better for income-seeking investors to look at defensive stocks at present.
Electricity and gas distributor National Grid and tobacco giant Imperial Brands are both regarded as defensive stocks because their sales are not highly correlated with the economic cycle – in other words they have large, stable revenues and are able to forecast ahead sufficiently to target dividend increases. Indeed National Grid has an above average yield of 4.5% and a policy of raising dividends by at least the RPI measure of inflation, which is higher than CPI, for the foreseeable future. Meanwhile, Imperial Brands uses its considerable cash flow to pay good dividends on a quarterly basis. It offers a 4.1% yield at present and aims to increase the payments by at least 10% a year, something it has achieved for the past eight years.
For those looking for some capital growth as well as rising income the City of London Investment Trust is famous for having increased its dividends for the past 50 years. Its top holdings include large multinational companies such as BAT, Royal Dutch Shell, HSBC, Vodafone and Diageo. The trust has a good long-term track record of outperforming the FTSE All Share index and perhaps best of all for long term investors it has comparatively low charges of 0.42%.
Those seeking a lower risk, low cost option should consider an exchange traded fund (ETF) such as the SSGA SPDR S&P UK Dividend Aristocrats. It tracks the S&P UK High Yield Dividend Aristocrats Index where the constituents are companies which can demonstrate growing or stable dividends for at least 10 consecutive years. As a result it features well-known names such as GlaxoSmithKline, Pearson and Carillion.
Forecasting inflation, and interest rate rises, is a notoriously difficult activity but the current level of uncertainty means that all of the above investments are worth considering for a diversified portfolio, and all are eligible for inclusion in ISAs.
Please remember, no news or research item is a recommendation or advice to buy. Every Investor is not responsible for accuracy and may not share the author’s views. If you are unsure of the suitability of any investment for your circumstances please contact an adviser. All investments can fall as well as rise in value so you could get back less than you invest.