Just like the weather in Australia, no two days are ever alike. The same could be said for investing. Six months ago, global central banks were discussing the nature of inflation as “transient”, with some factors like supply chains and stimulus spending expected to fade.
Then, in March, the Federal Reserve pulled the trigger for a 25 basis point hike, signaling that more would be on the way. The first Tuesday of May saw a similar fate for the Reserve Bank with the same conclusion – more hikes will be needed to contain inflation.
Antoine Golowenko and the MLC Asset Management team have been warning clients of the dangers of runaway inflation for months. In this latest episode of Expert Insights, we ask him about the team’s latest views on what inflation could do to the global investing landscape. Should investors fear the R and S words (recession and stagflation)?
Watch the video or access our edited transcript to find out.
OL: What is the probability of a recession in the next two years?
Antoine Golowenko: The inflationary environment, and let’s not forget, we’ve been through some pretty tough times and the health recovery, the effectiveness of vaccines, and now definitely the economies are on much stronger footing.
In our Investment Futures Framework, we have a range of inflationary scenarios. And probably as simple as it sounds, the inflationary type of nominal growth bias is real. Part of this soft landing, if you will, means that inflation can be accommodated and is largely under control, and we see an opportunity for equities to perform reasonably well as valuations can be constructive.
Now I will classify this as a soft landing. In a soft landing, a modest or mild recession, given the two and ten years we’ve had, that’s quite acceptable. So in this inflation, nominal growth skews real growth, and in this soft landing, mild recession, I think investors should be prepared.
Where we could go, and probably the most concerning aspect of this nominal growth, inflationary bias. Inflation is eating away at this growth. This makes it harder for earnings, leaner results and weaker valuations. This is obviously something that concerns us, but it is part of a broader context of inflation.
One of the elements of our term investment framework is that we are not interested in a single point or narrow range of cases.
It’s really about positioning our portfolios to be resilient across a wide range of potential future outcomes. And thinking about the likelihood of stagflation at this point, it’s certainly possible. From a consumer and inflation perspective, ultimately food, shelter, fuel and energy, and then health care. So among those components, energy costs are certainly high and in places like Europe and the UK as energy importers, without the ability to navigate efficiently while committed to renewable energy , I think they have less flexibility than in Australia and the United States in this environment .
OL: Are the markets ready for the coming policy tightening?
Antoine Golowenko: The tightening or tightening required, we began to see. The actual rate increase program, we are only at the very beginning. So looking at that, and I’m lucky that MLC Asset Management in that we have both equity and fixed income experience. I will give credit to the fixed interest team and the credit team for a multidimensional view of what could go wrong. I think we’ve seen quite a marked repricing in yield curves, fixed rate instruments, and there’s more opportunity. So credit where credit is due, they do a very good job there.
Actions can achieve this, but it is often about optimism. A multi-dimensional view of what might be going on – and that’s oversimplifying or trivializing. Having diversity in our teams, diversity in our debates, and building portfolios that way.
I think actions are and can do that. To the extent that profits and growth are not being generated, I think there is another element of valuation coming into equities.
OL: Is stagflation a possibility for the global economy?
Antoine Golowenko: Soft landing and soft landing, as well as a recessionary environment, can actually be good for capital and more efficient capital allocation. Stagflationary scenarios and, if you will, engulfment and the real difficulty of not containing inflation are doing real damage. And harms both the real economy and the financial economy.
Over the past 10 years, the financial economy has really outperformed. And more recently, we might actually start to see the real economy outperform the financial economy in the financial markets.
Stagflation is part of a wide range of scenarios, and the relevance of stagflation and inflation over the last three to four quarters of our process has increased.
We are not alarmed by this risk. We are open to it and position our portfolios for both offense or upside participation, as well as defense in your taste, diversity and how we can protect our portfolios.
MLC Asset Management’s portfolios combine their best thinking on asset allocation with a disciplined investment process – developed over 35 years – that optimizes returns and reduces risk. For more information, please visit their website.