What To Own In A Low Growth, High Inflation World?
Put simply: what do you want to own in a low growth/high inflation world?
It is an important question; one to which we have been giving some thought as the will it/won't it question about inflation continues to be debated daily.
Why?
Well, because of the tight relationship at present between quick changes of interest rates and economic growth.
As interest rates continue to rise, growth will continue to fall.....
There is a lot of focus on the former, less on the latter. And when it is discussed it is usually done in the context of a contraction of economic growth (i.e.: a recession).
That isn't a guarantee and although the non-recession scenario is a lot less sexy to write about it is also more likely.
A recession may still occur but the greater probability is simply for a high(er) inflation/low(er) growth world that we have mentioned/worried about before.
Well, what do you want to own in this world?
It is a very tough call.
If you think about your investments in terms of the classic 60/40 balanced portfolio, the choices become particularly stark.
You don't want to own bonds because the high(er) inflation element above suggests that most bonds will struggle as the Federal Reserve and other central banks are forced to raise interest rates.
Eventually that will shift but at 9.1% in the CPI you have a loooong way to drop before getting there.
And equities are equally challenging. Their profits are being eroded by the twin forces that are slowly annihilating company after company's share price.
If inflation stays high then it will continue to erode their margins and the central bank will be forced to continue to raise interest rates.
If inflation (and economic growth) starts to decline, then earnings forecasts are far too optimistic for most companies.
It is the ultimate lose-lose. And it is likely the single biggest reason many investors are so pessimistic at present. Even the most contrarian are struggling to find a positive path for the broader stock market.
So what do you do?
Here are 3 ideas or perhaps put more honestly, therapies:
Do nothing.
Stop buying - Avoid value traps.
Prepare to buy commodities again.
What to own in a low growth world obviously depends extremely on your context but if you are, as you should be, safely invested in low expensive passive ETFs then your best option may be to simply do nothing.
There are two reasons to follow this path:
The first is the standard advice that the very worst time to sell your investments is during a huge downturn. It is a classic error - the result of our primeval lizard brains - and often costs retail investors the most. Throwing in the towel often occurs near market bottoms and then you lose out on the sharp rebound off that bottom.
The second is simply that, rather than frantically scurrying around in a terrible market environment where nearly everything is struggling, the best move might be to stay safely, passively, cheaply invested and not try and accidentally maneuver yourself out of the frying pan and into the fire.
The second is a very close variant of the first but trading in and out of positions has a few costs associated with it :taxes and trading first among them.
Second, be very careful about what you buy in this environment. There is a temptation to look at certain companies - "great" companies - and think they are now cheap.
See our example below.
But that isn't necessarily the case. In fact, they can be traps. What has fallen may stay "cheap" for a long time, especially in a world where the economic regime is very different from the recent past.
Just because something has fallen 80% doesn't mean it can't fall another 50%.
You think you are buying hidden value but, in actual fact, you might just be buying someone else's garbage.
This theme of “someone else’s trash” is a good one to keep in mind, more generally.
As Bridgewater CEO Ray Dalio famously put it a few years ago: "Cash is trash." The reason he said so was, in an inflationary world, if you stay in cash you are losing value. However, the famous investor updated his phrase recently at the springtime Davos by pointing out that losing 8-9% per annum in cash is far superior than losing 20-25% in the S&P 500.
If you must buy, try to stick to low cost and passive ETFs that will help you both diversify your holdings and dollar cost average your wider portfolio.
Lastly, commodities have sold off tremendously over the last month. It isn't just oil either: nickel, lead, copper, oil, pork, all of the charts are roughly the same - even wheat! - have been falling steadily.
But we remain confident that, of all sectors and assets, commodities will do well in the weeks and quarters ahead.
The key caveat here will be: as long we manage to avoid a recession.
Why do we think commodities are special?
Well, as we have detailed for well over a year, because in industry after industry there has been nearly a decade of underinvestment in the space. There are simply few new mines, oil fields and new sources of supply. There are also shortages of engineers, miners and investors willing to take the plunge to go after the raw materials we use every day.
That tightness of available commodities across the spectrum suggests that though their prices will rise and fall as global demand ebbs and falls they will remain elevated compared to recent history and could continue to be one of the few bright spots in the global economy.
They key risk, one which we will devote more time to in the weeks ahead, is a true economic recession.
But, for now, let us return to the importance of avoiding value traps.
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Have questions? Care to find out more? Feel free to reach out at contact@pebble.finance or join our Slack community to meet more like-minded individuals and see what we are talking about today. All are welcome.
