Premier Miton Macro Thematic Multi Asset Team
This is the single most important question for portfolio managers over the coming months and years. If inflation is a temporary cyclical phenomenon as a result of pent up demand and consumer support programmes during the lockdowns, then the old investment paradigms will reassert. If we have gone through a structural change, the way many managers construct portfolios might need to change going forward.
The arguments in favour of temporary inflation surround the nature of the interventions which took place during lockdowns. Obviously, the closing of much of the global economy was a temporary measure as were the income support measures, which to some degree, sustained demand during and after lockdowns. These disruptions are now settling down and working their way through the system. Income support measures are rolling off, supply chain disruptions are beginning to ease and consumers’ initial desire to get out and spend is abating. Indeed, the global economy appears to be heading for a contraction, which is inevitably disinflationary in the near term.
However, these deflationary trends need to be considered in the context of some more structural factors. First to consider, is the basic nature of the global economy. For the period from the late 1980s until the last 5 or 10 years, the bulk of the world’s economy could be considered to be free market or moving in a more free market direction. Even China, and the former Soviet states have been becoming increasingly free economies. This is important, as free market policies are typically disinflationary, while central planning is more inflationary. We can see this clearly in how China’s opening up has driven falling inflation worldwide.
Recent trends have been much more in the managed economy direction. China is a prime example. Under Xi Jinping, China has become much more interventionist. Obviously this is clear with its Covid policies, but the new direction goes far beyond this. China, bringing some of its big technology success stories under much greater government control, is just one example of a move into a more statist direction. The same trends are evident in the West and worldwide. A more top-down interventionist world is likely a more inflationary world.
Another example of structural inflationary trends, along similar lines, is the interventionist energy policy that has aggressively been pursued in the West. Subsidies for renewables, combined with discouragement of fossil fuels and nuclear have given rise to higher inflation and lower productivity. The same can be said of the policies that have prevented investment in other heavy industries in the West. A lack of flexibility has been built into our economic systems as a consequence of policy, which ultimately has structurally increased inflation.
Now inflation has become an issue, governments across the world are making the same mistakes as in previous inflationary periods. Inflation at its heart is too much demand (money) chasing too little supply. Yet nothing is being done to address the supply side of the problem. Interventions are taking place which support people’s incomes, thus boosting demand. This will only exacerbate inflationary pressures. However, these are the only politically acceptable interventions; long term solutions are politically painful.
There are many other potentially inflationary factors at play in the world economy, including the retreat of globalisation, lack of investment in new mineral production, structurally increased transport costs due to regulation, and so on. We lean towards the higher for longer view on inflation for the coming years.
This has important impacts in both the short and longer term for markets. In equities, higher inflation implies lower equity valuations in the long run and favours value versus growth shares. We would argue this is not yet fully reflected in equity valuations. Higher bond yields are to be expected in the longer term, but perhaps in the near-term, economic contraction may present a favourable environment for government bonds at least. We remain very defensive, particularly as the trend in equities remains downwards.