Inflation could stay higher for longer as reshoring, tariffs and supply chain rewiring raise costs while corporate demand holds up, according to fund managers and strategists at Franklin Templeton.
Michael Brown, global investment strategist at the firm, said: “We're in a pretty good corporate world at this moment so it's not surprising that, when employment's good, when PMI [purchasing managers' index] numbers are good, when corporate earnings are good, when confidence is high and when capex is picking up, that we'd have an inflationary trend that could persist.”
Higher interest rates should come with increasing inflation and central banks around the world have either started or are bracing for a hiking cycle, including in the UK and in the US.
Normally in this kind of environment value managers are better positioned to outperform, but experts stressed that any changes done to portfolios should be at the margin.
Higher rates for longer
Reshoring is a key culprit for inflation according to Michael Feldman, manager of the ClearBridge Global Growth Equity fund within the Franklin Templeton group.
TSMC is the main example of this trend. The Taiwanese chipmaker is building manufacturing facilities in Arizona, a project that is forecast to cost the company and its partners $265bn.
Customers, he said, will pay a premium of 10 to 20% for the security of onshore supply, while TSMC itself absorbs “a 3 to 4% impact to margins” from higher US labour, land and materials costs and a workforce without Taiwan's scale.
The same dynamic is playing out across chips, energy, defence and industrial supply chains as other sectors reshore. European countries are spending more for defence, which also adds to inflation.
David Morgan, manager of the Putnam Global-ex US Core Equity fund, said the more structural shift is in how companies think about supply chains.
“Supply chain management used to be about getting the cheapest product possible to boost margins,” he said. “That's completely changed now. It's upfront as one of the most important aspects of managing a company today from a risk perspective.”
The idea of relying on a single-source supplier, he said, is “pretty much out the window” – a shift from price minimisation to resilience that carries its own cost, even if, as Morgan cautioned, “we haven't really seen that much in the numbers yet.”
For Brown, today’s environment resembles that of 2022, with bond markets and underlying inflation trends being very similar across the G7 markets.
“It’s a supply shock combined with a demand shock, and so those two elements are coming together. Unravelling the two is going to be impossible.”
Yet markets have so far taken the prospect of higher rates in their stride.
“Rates may rise, but we don't think they'll go up as much as the market anticipates”, he said, and that resilience is “a function of corporate strength”.
Don't try to be a hero
But all this positivity won't necessarily translate into investor gains. Simon Wood, head of listed markets at Brunel, said higher inflation and higher interest rates for longer call for an increased value exposure in portfolios.
“I would never make a big call either way, but in a rising interest rate environment, you just need to lean into your value management,” he said, with value managers “typically doing better in inflationary environments”.
That said, big directional calls are best avoided, as is chasing the rankings of best-performing managers. From his career as a multi-manager, Wood recalled letting growth manager Lindsell Train “drift up” through the 2010s into 2021 while letting Jupiter Special Situations, a more value name, drift down.
The key thing is that he “wasn't doing anything clever,” he said, rebalancing only occasionally.
“What's gone wrong with most people in multi-management is they've tried to be a hero,” he said. “They try to be first quartile, and that's exactly what you shouldn't be trying to do.” He added that some of his peers who had made bold macro calls had gone on to fall from first to fourth quartile as a result.
“I don't think you buy a fund of funds for macro calls, you're buying it to be diversified. So everything you do is just at the margin.”