Who is not afraid of the inflation bogeyman? Ehhh nobody. Even the dog on the street knows it is going to be a long and complicated path before price gains moderate.
Meanwhile, the International Monetary Fund (IMF) has pencilled in a return to inflation target after 2025 in most cases.
It’s unsurprising that a growing chorus of local chief executive officers (CEOs) are raising concerns about rising costs according to the March 2023 CEOs survey conducted by the Central Bank of Kenya.
The inflation index jumped 9.2 percent (February 2023, April numbers coming out on Friday), after rising nine percent (January 2023) - strong inflation readings are in sync with several business surveys showing an acceleration in cost pressures.
The big question is; if the impact of higher costs is expected to be significant in the months ahead, how should investors interpret this?
To start with, sentiment-based surveys are never easy to interpret. In any case, the apex bank does not tell us to what extent it relies on them to provide key input for its policy-setting activities.
Anyway, for the average investor, it doesn’t hurt to add to your bag of indicator tools. On the face of it, should cost pressures push higher, short-term, I think it will be a struggle for many listed firms.
Rising costs will certainly dampen valuations for stocks with low current earnings.
And considering that not so many enjoy strong pricing power currently - only banks are reaping good going by the impressive Q4 2022 results - there’s less investor comfort when it comes to expecting increasing profit margins.
Bond investors, meanwhile, would likely be more negatively affected by any persistent pickup in inflation that gnaws at returns.
Not coincidentally, recent apathy around bond issuances and the heavy preference for short-term papers say a lot about investor thinking on inflation and near-term rates.
If cost pressures dynamics change - and they do change over time, the long rains are here, thankfully -, there are still other bogeymen lurking in the dark.
Namely; the anaemic global growth, which is most likely the macroeconomic outcome in the next 12 months, high crude oil prices, and a weaker currency expected to trade lower over the course of the year owing to debt servicing obligations.
Year to date, the shilling is down 9.5 percent against the US dollar, the below-average growth private sector credit - currently pacing at 11.7 percent (February 2023) compared to 12.7 percent (December 2022), et cetera.
To put it succinctly, expect profit erosion to be excessive, hitting a relatively higher percentage of companies.
In summary, sustained inflation is here to stay at least for the foreseeable future. Individually, it’s the single biggest danger to the stock market.
If higher-than-expected inflation continues to be the predominant driver of those bearish fears, the share market will continue to be under strong pressure.
To date, investors have lost over 15 percent according to the broad Nairobi Securities Exchange All Share Index.
With heightened inflationary risks, it is within reason to expect subdued performance as economic growth prospects for the next 12 months remain sub-par.
The writer is the MD of Canaan Capital.
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