Transition time for markets
The key themes of the new era aren’t yet clear – but we’re prepared for inflation to stick around
We’re one year on from the point where central banks belatedly began raising interest rates and it’s still far from clear what this new investment era will be like. Many sensible analysts seem to doubt that it will be vastly different to the past decade: they expect inflation to tick back down to around the 2% target, and rates to be cut significantly in response to slower growth and the threat of recession.
Our MoneyWeek ETF portfolio tries to avoid staking everything on a specific idea – it aims to be positioned for a broad range of likely outcomes. I don’t believe I have any greater skill in forecasting the economy than anybody. Still, the path to this scenario feels narrow, because the world has changed greatly in the past few years.
Supply-chain security – “reshoring” and “friend-shoring” – is a much bigger theme than it was. This seems intrinsically inflationary, so long as you accept that it was the shift to making so much in China that held down prices over the past couple of decades. The focus on energy security and the energy transition – after at least a decade of underinvestment in the sector – also appears inflationary. Some argue that ageing demographics are deflationary, but that’s not clear – there are valid arguments that global ageing will be inflationary. In any case, this is much longer-term pressure and surely outweighed by other factors in the medium term.
Pent-up demand will support prices
Meanwhile, for all the fears about the cost of living crisis and recession, the reality seems to be that anybody who can spend wants to do so – perhaps a combination of believing that things will get more expensive (inflation expectations) and just wanting to get on with life (the pandemic aftermath). This evidence of pent-up demand implies that recessions may be short-lived.
This is reflected in our ETF selection. We have nothing in nominal government bonds, but we have a small amount in US inflation-linked bonds (US bonds will probably do better in a crisis than UK ones). We have gold, because we think it will do well in severe inflation – and indeed it has done well for us lately (up 18% since the start of 2022). We have oil and gas – a leaf from the 1970s stagflation playbook, when energy was both a cause and a beneficiary of high inflation. We still have some real estate. Notwithstanding fears about a credit crunch in the sector, history suggests it should do well in a scenario in which inflation consistently runs above interest rates.
It’s not clear which stockmarkets are likely to do best in this new regime, so we remain fairly evenly balanced between different categories for now. Cash need no longer be such a drag, thanks to higher rates on savings deposits or moneymarket funds. In short, while there’s nothing to celebrate in terms of performance – we’re flat in nominal terms over the past year – there’s no obvious reason to change right now.