- Macro Strategist
Switzerland, Intermediary
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For some time, our research has suggested we are at the start of a regime change. But is that thesis still valid as inflation and the resulting need for central bank tightening appear to be receding? What conclusions, if any, should investors draw? Below, I set out my thinking on why, despite signals to the contrary, this new world is here to stay and explore how investors can navigate what may be the most momentous macro shift of the last few decades.
The old era is over
For most of the last 20 years, we have lived in an environment where inflation has been structurally low across the globe driven by a range of factors, most notably globalisation and the rise of China as the workshop of the world. As a result, the global economy benefited from highly stable macro conditions. Essentially, we could observe two states:
- Growth/no inflation: Economies enjoying growth without a meaningful pickup in inflation for a very prolonged period. This situation was ideal from a policymaker’s perspective as it didn’t necessitate policy trade-offs; and
- No growth/no inflation: When economies experienced low growth or recessions they did so with still very low inflation. In response, central banks were able to pump as much liquidity as they could into the system to kick-start the economy and stave off the risk of deflation.
In my view, that setup is now past tense across the developed world as inflation is back, even in Japan. We have been seeing disinflation for several months and central banks may eventually undertake some of the rate cuts markets are hoping for, but I believe it would be wrong to assume that we are going back to familiar territory. It might feel and sound like last year was the aberration, but I would argue that in fact the previous 20 years constituted the unusual period and investors can learn a lot more about where we're heading by looking at the 1970s.
Welcome to the new (retro) era
So, what are the 1970s, and to a lesser extent, the 1980s telling us? They suggest that we are returning to a world characterised by much more frequent and shorter cycles, with inflation that is structurally higher and more volatile. I see the likely road map for the next 10 years following a similar trajectory for two key reasons:
- Deglobalisation caused by geopolitical rivalry, concerns about the fragility of supply chains and the accelerating physical impact of climate change; and
- Bigger labour share of income given governments’ intentions to address growing income disparity.
Both developments imply that inflation is here to stay. As well as being structurally higher, inflation may also be more volatile than in the recent past, meaning that policymakers now face a tricky trade-off between growth and inflation. When growth slows, inflation may, at times, still be high and hard to dislodge without painful adjustments. Central banks will therefore need to make a decision about what outcome they fear the least. The message from all central banks over the last six months is that they want to avoid an unnecessary recession due to overtightening, rather than sticky inflation, thereby increasing the likelihood that inflation is going to remain entrenched in the system for longer.
This new paradigm has unsettling implications for asset prices and the correlation between assets. In particular, with cycles becoming shorter and more volatile, the correlation between equities and bonds is likely to fluctuate, thus reducing bonds’ reliability as a hedging asset in multi-asset portfolios. Asset prices also will have to adapt, and I foresee much more differentiation between countries and even sectors and companies. In my opinion, markets haven't yet accepted the regime transition as they still want to sing from the hymn sheet that they have been using for the last two decades. This behavioural bias implies that investors should brace for potentially disruptive adjustments as markets reprice for the new reality. More broadly, while this new epoch may have a distinctly retro feel, it is unlikely to be a carbon copy of those earlier decades, as demographic change, geopolitical rivalry, climate change and technology are all likely to add further uncertainty and volatility.
Embrace the change
This new era may feel daunting, but it also offers a significant potential upside for discerning investors. I've been in global markets now for 30 years and this is the most complex macro environment that I've lived through, but it’s also the most exciting.
For instance, I think current economic growth forecasts are too downbeat, and I expect growth to surprise on the upside. Even if much of that growth is nominal (owing to inflation) rather than real, it still may translate into attractive investment opportunities. However, to succeed in this new era, I believe investors need to really understand where we are in the cycle and have a handle on the implications of the broader macro backdrop for their portfolio positioning. With cycles likely to be shorter and more volatile, being nimble is also going to be more important. In addition, I expect greater divergence between winners and losers, meaning investors’ in-depth knowledge of the companies and issuers in which they invest is more crucial than ever.
In summary, in today’s environment, active management grounded in deep research across multiple perspectives may offer a distinct advantage.
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