June was another good month that exceeded expectations in the international securities markets: Shares of large US companies rose 5.4% in euros. The rise in European stock markets was somewhat smaller, reaching 1.6%.

Now that vaccination is gaining momentum and countries are opening up their economies, consumers have also opened their wallets more boldly. They are willing to spend and invest after being held back or prevented during the lockdown.

As the floodgates of consumption opened, prices have risen, with fears that inflation could pick up even faster. In addition to increased demand, price growth is also fuelled by the fact that investment in several industries has been held back in recent years, which in turn has reduced supply.

You can’t blame the Coronavirus for everything. For example, the US–China trade war has affected the supply chains of major global companies, while combating climate change has made mining companies more cautious about the profitability of new deposits.

At the same time, several deflationary factors, such as population ageing and technological developments, are counteracting the rapid rise in prices and have, indeed, slowed down inflation for decades. It should also not be expected that the governments’ “generosity” seen during the pandemic will continue long-term: the budget deficit will be reduced in the near future both by cutting subsidies and raising taxes.

Although the prices of individual commodity groups may jump in the short term, I do not believe inflation will accelerate significantly in the next two or three years. In the past 18 months, the debt burden of governments, companies and households has increased considerably almost everywhere in the world.

After a short consumption surge, we will probably see a period of austerity again. Businesses and households simply cannot spend very much more in the long run than they earn. The governments of the world’s largest countries do not have this restriction, but government-sector growth can only come at the expense of or instead of private-sector growth.

New equity and bond investments

While stock markets as a whole moved higher, the commodities sector, on which the LHV pension funds have recently focused more than before, moved in the opposite direction in June. Achieving climate neutrality requires significant changes in this sector and can offer opportunities. Several Nordic companies are well-positioned in the energy sector, which we added in June as new investments in our higher-equity risk funds.

Overall, bond markets offer very few attractive opportunities at present, but these do open up from time to time. At the beginning of July, we acquired three-year bonds of Eastnine, a real estate company focused mainly on office buildings in Vilnius, with 5% interest per annum. As the bonds are listed on stock exchanges, their price may rise further.

As for investments in unlisted assets, we continue to actively seek opportunities in the real estate markets in all three Baltic countries. While real estate and forest land currently account for about 15% of the assets in LHV’s largest pension fund L, the share of real estate in the fund’s portfolio will increase to 20% in September after the wave of exits due to the pension reform.

Historically, the rental yield of Estonian commercial real estate has exceeded 6%, and the return on equity has been well over 10%, depending on the leverage. I believe that local real estate is a very important asset class for pension funds, as their success is primarily measured by higher returns than wage growth.

However, the commercial real estate sector is also open to broader macro trends. As LHV pension funds have invested in real estate both directly and through real estate funds, the rising prices of commercial real estate make me happy, but sometimes they also make me scratch my head. What kind of rental yield can be expected in the future if price increases continue at the same pace, or how will real estate prices react if interest rates should rise by a few percentage points?

While keeping up with the herd or being at the helm is a great tactic in an emerging market, it is no substitute for long-term strategy or independent thinking. Demand and supply are important factors that must not be ignored, but it is also essential to understand the factors that affect supply and demand and the balance between them.