Stagflation, the foul-weather friend

Until the 1970s, it was thought that stagnation and inflation just didn’t go together. But then came the realisation that you could, after all, have low growth and runaway inflation at the same time. This revelation quite literally brought the two words together to form what is now known as ‘stagflation’. And stagflation, while bad news for an economy generally, is – on one reading at least – good news for infrastructure as an asset class.

A recent report from Swiss private investment firm Partners Group concluded that, in the stagflation-type environment which Partners believes is characteristic of many advanced economies today, infrastructure represents a good bet if you’re an investor. In particular, the report recommends “yielding, brownfield infrastructure assets with inflation-linked revenues in Europe, North America and Australia”.

More capital, more swiftly

At the demand level this is significant, as recommendations from the likes of Partners Group may help to channel more capital, more swiftly into the asset class. While many Canadian and Australian institutions have infrastructure allocations of ten percent or more of their overall portfolios, in Europe and North America that figure is typically much less – even some European pensions viewed as having an enlightened attitude to the asset class may only have a miserly two or three percent dedicated to it. There’s no obvious reason why this gap between Canada, Australia and the rest shouldn’t close – and surveys like this could play a part in precisely that development.

However, growth in demand is not driven primarily by considerations of the macro-economic backdrop. Most pensions are by now surely sold on the argument that investing in infrastructure performs a vital long-term liability-matching function and will therefore continue committing more capital to the asset class for that reason alone.

Perhaps the greater concern for those with a vested interest in the continuing growth of the asset class is on the supply rather than the demand side. If it’s true that advanced economies are indeed experiencing stagflation, this is likely to negatively alter supply-side dynamics. Remember that in the wake of the global economic and financial crisis, infrastructure was part of many governments’ fiscal stimulus programmes, designed to kick-start economic growth.

But with an increasing number of economic observers regretfully concluding that printing money has not had the desired effect, different weapons will be seen as necessary henceforth to catalyse growth – and new and improved infrastructure may revert to ‘nice to have’ from ‘must have’ in the minds of policy makers. (As an aside, it will at some stage be worth revisiting the promises of cash that were made when those infrastructure programmes rooted in fiscal stimuli were first drawn up to see how much of that money actually got allocated and spent. Sceptics may feel they already know the answer, more or less).

On the other hand, there is currently no consensus about whether stagflation is or is not being experienced within given markets. The UK, for example, looks prima facie like the kind of stagflation-type environment Partners Group has in mind. However, there are hopes that the UK’s low growth/high inflation combo is a temporary phenomenon with inflation expected to fall due to weak consumer demand driven by slow wage growth. This, strictly speaking, is not stagflation, since stagflation implies a long-term state of affairs which becomes intractable (think Japan’s ‘lost decades’, for example).

This is significant since, all the while hope remains that the world’s advanced economies are not being plunged too deeply into the trough by efforts to reduce their debt burdens, policy makers will continue to feel justified in focusing on their current preoccupation of deficit reduction. And this has the prospect of really good news for infrastructure’s supply side.

In the US, for example, reducing the deficit could be greatly assisted by monetising a substantial portion of the government’s fixed asset base. If acted on, it would open up the US infrastructure market to private capital in a way only dreamt of up to now. And this would almost certainly be a much bigger prize for infrastructure investors than the asset class happening to be a relatively safe haven amid unremitting economic bleakness.