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Alan Martin, investment director at Rathbones Investment Management International, explains how inflationary shocks have created a need for investors to adapt to gain rewards
INFLATIONARY shocks caused by the pandemic and war in Ukraine are finally unwinding.
The world has changed since the late 2010s and we are not returning to the environment of ultra-low interest rates which existed before those shocks hit.
Strategies today will, therefore, look different from those that worked best in the low-rate, low-volatility environment of the last decade.
Although the war in Ukraine continues, prices of key commodities such as gas and wheat have dropped to lower levels than those seen before the incursion.
The once-in-a-generation chaos in global supply chains has largely abated as the world adapts, reconfiguring trade routes and learning to live without Russian supply.
However, geopolitical rivalries have intensified and awareness of the dangers of climate change has increased. Western governments favour active fiscal policy in contrast to the budgetary consolidation of the 2010s. Consumers’ balance sheets were strengthened during the pandemic in contrast to the picture seen during the global financial crisis when households’ finances were damaged.
The full implications of these changes will take years to become clear but we are confident about two things. First, interest rates will stay higher on average, and, even when they fall, the drop will not be to anywhere near zero.
Secondly, volatility in inflation, interest rates and economic performance generally will be greater, reflecting a combination of things including the risk of greater geo-political and climate-related shocks. In some ways, these changes should not be at all surprising. The 2010s were unusual, with the lowest interest rates in centuries.
From an investor’s perspective, this creates a need to adapt, but it also presents opportunities. This is particularly evident in fixed income.
For example, UK gilts with a maturity of two years offered a yield of 0.5% two years ago, whereas today it is more like 4.75%*. Looking at long-term predictions for returns on various assets, fixed income shows up more favourably at present and may become more prominent within portfolios.
The Bank of England appears to be coming towards the end of its cycle in raising rates. The pace of rate rises is affecting the economy, with inflation falling, house prices falling and business activity contracting. While we still advocate investing in equity-type risk, we do believe this adds to the tactical appeal of gilts, which, in past cycles, have performed strongly ahead of the start of rate cuts.
*uk.investing.com/rates-bonds/uk-2-year-bond-yield.
