The famous economist Milton Friedman once said that “inflation is always and everywhere a monetary phenomenon”. We have long disagreed….Read More
As we start to think about the next stage for our business, it is only natural that the mind should wander back to the early days of our company’s existence. Twenty years ago, when we created our company, financial markets and the world, in general, seemed calmer and more predictable. Writing our views was a simple and enjoyable task, as events were just less stressful; so much so that I even remember filling space in one of our “Views” writing about the dull prospects of Japanese elections. How we would all love a slow news month now…
In 2008, everything changed, in our opinion. The combination of the financial disaster and the extraordinary shift in central banks’ actions ensured that investment life would never be the same again. The years since the Great Financial Crisis (GFC) of 2007-9 have brought (in no particular order): commodity booms and crashes; rolling economic and financial distresses in Europe; a gaping chasm in the fortunes between the rich and the poor; growing volatility and extremes in political views; wild swings in sentiment towards emerging market assets; a bubble in US investment markets; the lowest ever recorded interest rates and bond yields; growing distrust amongst many countries as we move towards a “multi-polar” world; the onset and the lingering concerns of the COVID medical crisis; and, most recently and of greatest concern at the moment, the outbreak of war on European soil.
If there had been a current Nostradamus with us back in 2008 who had outlined what the next decade or so ahead would have offered, investors would have baulked at the prospects for financial markets and sought the safety of cash, thereby missing out on a golden period for investments. Indeed, despite the myriad challenges that investors have faced since the GFC, it has been possible to make excellent returns in both nominal and real (adjusted for inflation) terms. To be clear, we feel confident that we will be able to do so again in the coming years. There might be an inclination to utter the most dangerous four words in investment history, “it’s different this time”, given how miserable the current outlook might appear, but the truth is that it is never that different. Certainly, we might well be in for a period of nerve-racking volatility in the months ahead, and it might be structurally harder to have the same smooth success that investors enjoyed in the 2010s in the “Turbulent Twenties”, but history teaches us that we adjust to an ever-changing world, and, in simple terms, asset markets rise over time.
Sit back and enjoy the ride?
If that view is correct and ultimately investors should just own assets and let time do the hard work, should we look through the current market travails and take a very passive approach to managing our clients’ assets? We believe that would be a mistake. While the future over the long term will likely bring rewards to investors, the short to medium term appears a greater challenge for us all. If we compare the last decade to the current decade, we are likely to see a variety of different conditions that we must factor into our asset allocation decisions and our investment selections. Whilst the fast and furious action of the last two years has rendered the last decade “ancient history”, we fondly remember the era of low inflation, low interest rates, low but positive economic growth and high asset market returns. It was an era of relative calm manufactured by central banks and encouraged by short-sighted governments, who threw fiscal discipline out of the window and concentrated on short-term satisfaction.
We live in a new regime
Fast forward to today, and the world is a very different place. Inflation is now everywhere, and is becoming a psychological issue. Interest rates are rising and forecast to increase rapidly through this year, at least. The calm created by ever-supportive monetary policy now appears to be over. Economic growth is unpredictable but is likely to be at similar levels to the last decade, though with a “bumpier” profile in the coming years. Governments will surely at some point feel that they need to rely less on persistent debt creation and try to balance the books. That being said, however, with the current crop of politicians around the world, this might be wishful thinking.
Don’t despair, think differently
Investors might digest these views and want to get “off the ride”. One could easily put these ingredients together and assume it would be a toxic cocktail and a dangerous time to be an investor. We would disagree. Yes, it seems certain that asset market returns will be harder won in the rest of this decade; this much is nearly certain given the structural overvaluation of core asset markets, which have hitherto been supported by the central banks. Such a broad assumption would however miss the less obvious point that if one is willing to look hard and investigate lesser-known investments, there is a rich seam of investment opportunities for us all to exploit.
A polarised investment world
We can quite easily separate the investment world in to two different spheres of assets: many that are presently “expensive”, and a smaller number that are “cheap”. Our view is that most investment portfolios still hold a backward-looking investment approach and are focused on those assets that performed best in the last decade. As we have already outlined, we still expect asset markets to continue to gain over the long term, but as we move further into the 2020s we are expecting to see very different investment conditions to those we have experienced over the past ten years; as such, is seems likely that investors will need to recalibrate their portfolios for the years ahead. We feel strongly that there could be a continuation of the dramatic reversal of fortunes of both the previous leaders and laggards as the rest of this decade progresses, seen so clearly in the opening months of 2022. We are confident that we are sensibly positioned to take advantage of these shifting dynamics.
What could make us “wrong”?
Given the shifting sands in front of us, it is only right that we spend a lot of time thinking about what would make our views wrong and render our investment strategy less effective than we might hope. The chief “relative” risk to our strategy would be if we were to suddenly return to the previous conditions that investors enjoyed in the last decade. A substantial and sustained reduction in inflationary pressures would allow the central banks to discard their current intentions to tighten monetary policy. Almost certainly, for the previous low inflation and low interest rates trend to reassert itself, we would need a quick and secure resolution to the distressing conflict in the Ukraine and an improvement in the dislocations across global supply chains. However, should this “easy environment” prove to be the future, then investors could perhaps simply return to the buy, hold and relax strategy that served them well since the GFC.
Could investment markets deteriorate rapidly?
Another possibility could be that we are too sanguine over the outlook for asset markets and, rather than an approach of selectivity and differentiation, we should simply be far more defensive than we currently are in our investment positioning. The situation in the Ukraine has opened a wide range of geopolitical outcomes that it would be irresponsible to ignore, chief amongst them the risks created by significant disruptions in global commodity supplies. Moreover, the chance of an accident occurring between Russia and the NATO countries has risen exponentially. As well as such risks, we have long warned of the societal hazards brought about by the entrenched economic “unfairness” that has flourished in the last few decades, nurtured by the hands of the central bankers and politicians. When one also mixes in the threats of destabilising inflation and the potential for higher interest rates, one could easily craft a conclusively cautious outlook. We are certainly not avoiding the “worst case” scenario and such concerns are reflected in our asset allocations, allowing us to mitigate the worst falls in many asset markets so far this year.
Our base case and conclusions
We believe that a return to the “old normal” is unlikely, but we also hope that the world will avoid the “Armageddon” scenario. Our expectations are that the inflationary genie is now out of the bottle and that, broadly, inflation will be volatile, but on average it will be higher in the decade ahead than it has been for over thirty years. We fear that a “stagflationary” economic scenario is possible, with low rates of growth and higher inflation, which will be a chastening experience for central bankers bereft of any easy options. Our central expectation is for low rates of real growth, with shorter economic cycles and the painful prospect of an energy-driven recession never far away. What we must do is find those investments for our clients that already reflect the uneasy period ahead for the global economy. The good news, which hopefully gives you confidence in this time of global stress, is that there are plenty of “unloved” investments for us to choose from currently. Our basic message is that we remain as cautious about overall markets as we have been since 2018, but more enthused about the prospects for certain investments than we have been in nearly a decade. Indeed, many investments are already at or close to valuations that we saw briefly in the panic of March 2020. Whilst uncertainty dominates, we are focusing on one of our key investment philosophies: that the best way to make positive returns is to buy good investments at cheap prices and hold them for a long time. Sometimes it makes sense to keep things simple in a complicated world.
Please get in touch if we can answer any further questions you might have at this time.
Thomas Becket, Chief Investment Officer
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