“Life moves pretty fast. If you don’t stop and look around once in a while, you could miss it.” – Ferris Bueller, Ferris Bueller’s Day Off (1986)
We leave it to the readers’ imagination why a film about a high school slacker resonates with the Multi-Asset team. But the post-pandemic period has been one of the most intense of our careers – it’s all too easy for investors to get caught up in the market narrative. Our job is to take a “day off” from the hyperbole and make sense of what’s happening. We predicted back in April 2020 that the sugar rush of pandemic stimulus would kickstart a warp-speed business cycle, and it did. After the fastest recession there was the fastest recovery in history, and now markets are worried things are moving too fast. The market narrative has flipped from deflation to reflation to stagflation to inflation in a matter of weeks.
Don’t rely on inflation fading next year
The Fed is banking on inflation fading next year, but it may be more persistent . We analyse current inflation across four key buckets: reopening-related sectors, housing, wages, and expectations. All are moving higher. Inflation in rents is sticky and can contribute to higher inflation expectations, which reinforce longer term inflationary dynamics. Central bank policy is running a risk of going too slowly now, and having to move at a faster pace further down the line, choking the recovery.
Heading into 2022, we think growth can be sustained and support markets. Supply bottlenecks have left inventories low, and restocking can sustain industrial production. Accumulated savings (of around 10% of GDP in the US) can continue to support consumption. As we head towards the middle of next year, restocked inventories, slowing consumer demand, tighter policy and stretched valuations will make life more difficult. Conclusion: one can continue to ride the wave in equities and hold fewer bonds for now, but the likelihood is the flexibility to cut risk and add duration2 later next year will be needed.
Looking beyond the horizon
Looking out into the more distant future, structural shifts point to a modestly stronger growth and inflation environment. Pandemic stimulus cheques and asset price rises allowed an increase in retirements, reducing labour supply, but lifting wages. The pandemic and trade wars exposed global supply chains, leading to a structural shift from “just in time” to “just in case”. We have seen increased capital expenditure and in particular increased spending on research and development since the pandemic, which can drive productivity and growth. Last but not least, the need to fund climate transition can unlock additional fiscal spending and potentially forms of ‘green’ stimulus. There seems to be little chance of a return to the austerity of the previous decade.
These factors will take some time to play out, but the sum of their impact is likely to be a modestly higher growth and higher inflation environment over the next decade, particularly compared to the previous one. Shifting policy is also likely to lead to higher volatility, and more frequent, sharper crises. Simple balanced portfolios of higher quality equities and longer duration bonds are unlikely to work as well as they have.
This doesn’t necessarily mean investors can’t make decent returns, but it will call for different approaches. As Ferris said, “you’re not dying: you just can’t think of anything good to do”. We think this sentiment applies to investing: you can still perform, but you will need more flexibility and a wider range of return sources.
2 Duration estimates the sensitivity of a bond or bond fund to changes in interest rates. It is measured in years. The longer a bond’s duration, the more sensitive it is to interest rate movements.
Read more about outlook 2022
Contingent Capital 2023 Mid-Year Outlook: Down but not out
The twin risks facing bond investors
Making the case for convertibles
Global Sovereigns: Best entry point in a decade?
The value of active minds: independent thinking
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