The pursuit of lasting prosperity
- Growth is likely to be hit as major central banks work to contain inflation
- Inflation will take considerable time to contain and control
- Investor portfolios need to be prepared for more turbulence
- See our latest asset class views.
In ancient and modern times, inflation has remained one of the policymakers’ most undesirable economic problems. Once entrenched, inflation can have broad negative implications across the economy and all aspects of society, thus eroding prosperity.
Thus policymakers, in their pursuit of creating long-lasting prosperity, always fear inflation and do whatever it takes to control it. Getting inflation under control has almost always required policy actions that have short-term negative implications for the economy and markets. From a central banker’s perspective, short-term pain is acceptable in the pursuit of lasting prosperity. Take, for example, Chair Powell’s recent comments:
“The process of getting inflation down to 2 percent will also include some pain, but ultimately the most painful thing would be if we were to fail to deal with it and inflation were to get entrenched,”
Similarly, Fed Chair Arthur F. Burns made a similar statement back in 1970,
“To regain a lasting prosperity, a nation must have the good sense and fortitude to come to grips with inflation. There is, however, no painless way of getting rid of the injustices, inefficiency, and international complications that normally accompany an inflation.”
Thus, investors are well-advised not to underestimate policymakers’ resolve to rein in inflation and inflation expectations. In creating long-lasting prosperity, policymakers will likely make decisions that will put both the economy and financial markets at risk. There are no easy, painless solutions. Indeed, challenging and painful policy decisions are needed and presented as such but also as actions that will cleanse the economy and markets of irrational exuberance, speculative or otherwise.
Since Q2 2020, signs of speculative exuberance have been widespread, triggered by the extraordinary and historic monetary and fiscal policy response to counter the pandemic and its headwinds. Major central banks have put over $11 trillion of quantitative easing in play. The speculative exuberance or asset price inflation has been evident across all regions. For example, 2021 witnessed 2,683 IPOs, a record number of new listings, and a 178% increase over 2020, with triple-digit growth seen across all regions. The global mergers and acquisitions activity was also astronomical, hitting a record high of USD5.9 trillion in total size, a 64% increase over 2020, with a deal count of over 63,000!. The global equity market posted a gain of over 14% in 2020 and a near 17% gain in 2021, with the largest volume of shares traded since 2004 as P/E ratios moved, in many markets, to historic levels. Signs of speculative exuberance and asset price inflation were widespread. This was, in our view, rational – not irrational – exuberance, given the policy support and the low level of interest rates, which made investments and allocations to markets a rational investor response.
Looking forward, we expect policymakers will remain acutely focused on fighting inflation. Thus, growth will decelerate further. Yet, we expect inflation to remain at levels considered problematic. Markets will continue to experience turbulence and elevated volatility. Moreover, as the inflation fighting intensifies, earnings growth will come under more significant pressure. Higher rates, slowing economies, and still elevated inflation levels will eat into profit margins.
There will be casualties in the pursuit of lasting prosperity as central bankers across the planet work to get inflation under control. The best way to manage such challenging conditions is to have a well-diversified portfolio with a preference for defensive markets and defensive allocation strategies, including hedge overlay solutions.
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