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Bull dozers

Last week was never likely to be one of great market activity. I certainly hope it was not but then I am abroad at present, visiting one of those countries held in the bosom of the European Central Bank. You can draw your own conclusions as to whether I am favouring Celtic rain over southern European sunshine.

Reading the myriad of research notes that came my way over the Easter weekend, I was comforted to find I am not the only market comment-ator caught out by prevailing bullish market sentiment.

But there is a theme that persists in much of the commentary available and which I have thrust at you many times before, inflation is back. The consequences appear in so many of the articles I am reading at the moment and feel present every time I fill my car with fuel or visit the supermarket. Everyday things cost more and if your earnings are not rising to match your expenditure, you have less to spend.

This is not a very encouraging scenario and one you might reasonably expect would cap any advance in share markets. But life is never that simple. High inflation that is out of control is a negative influence on equity markets. It is positively destructive for bond markets but even these have held up remarkably well of late. The inference is that inflation is containable and will not attain damaging levels.

So far so good. I am not dismissing the popular view that inflation has peaked and the rise in the cost of living will moderate but I am not so sure it will return to sub-governmental preferred levels swiftly.

Aside from anything else, the cynic in me says that because a little bit of inflation will devalue debt and help the austerity campaign on its way, our current administration will not act too prematurely to head it off.

Of more importance is that imported deflation from China seems to have come to an end. The Chinese currency is appreciating, workers are demanding more, their consumer culture is developing fast and, not to put too fine a point on it, they are becoming economically independent and able to call the tunes, rather than dance to them. The result, for us, is that businesses are regaining pricing power.

None of this makes me bearish of equities medium term, although I am delighted to report that there are plenty who feel we are approaching financial Armageddon. Just a few days ago I was sent an email directing me to a video urging me to dump just about every financial asset I might own. The arguments were not without merit but missed some of the salient points in a continuing low(ish) inflationary environment.

Take property. You only have to compare the prices at home with that in some of the more thinly populated but attractive regions of Europe to realise a significant adjustment has already taken place.

UK residential property undoubtedly became too expensive but the fall that has taken place now means replacement costs are, in some instances, approaching secondhand values.

At the higher end, in London, for example, prices remain only just this side of ridiculous. But for the great majority of us, property prices are underpinned by what it costs to replace where we live and the continuing restricted credit conditions means new building is falling behind demand big time.

A similar argument could be applied to plant, equipment and materials for business. Inflation, if not too severe, is good for financial assets.

Brian Tora is an associate with investment managers, JM Finn & Co


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