A new year – the time when commentators are typically asked to predict the big themes for investors over the coming 12 months. I am not averse to reading such lists myself – or indeed writing them.
It is always worthwhile keeping an eye on the future and the quiet days after Christmas provide a good opportunity to pause, take stock and think about what might lie ahead. Recent events have reminded us, however, that the biggest influences on the investment landscape in any given year often come from left-field.
Over the break, I looked back at some of the economic predictions made at the beginning of recent years. Going into 2020, a sluggish year for the global economy had ended with tentative signs of improvement. Trade wars were still front-of-mind for global investors – would tensions between the US and China escalate ahead of the presidential election? For the UK, the path of Brexit was still the biggest story in town.
On the last day of 2019, with the ink still drying on many forecasters’ outlook pieces, the local health commission in Wuhan, China issued a statement about a cluster of cases of viral pneumonia. We all know what happened next.
Notable by its absence
At the start of 2021, meanwhile, commentators were cautiously optimistic. Vaccines had been approved and were ready for rollout. New variants posed threats and the exit from the pandemic would be uneven, but the strong recovery looked set to continue, helped by ongoing policy support in some of the major economies. Broadly speaking, those calls were correct but one word is notable by its absence from 2021 forecasts – inflation.
Former US treasury secretary Larry Summers sounded early alarm bells in a February opinion piece in the Washington Post, in which he warned that new US president Joe Biden’s planned stimulus package was too big. Nevertheless, it still took a confluence of factors – from Covid outbreaks in Asian ports to the reluctance of workers to return to badly paid, low-satisfaction jobs – for worries to really take hold.
In the UK specifically, the ongoing post-Brexit adjustment might have been expected to cause some inflationary pressure, but that this would come at the same time as a surge in global gas prices, for example, was harder to foresee. As a result, following the first rate-rise from the Bank of England in more than three years in December, the path of interest rates looks more uncertain than it has for some time.
Risk tolerance and goals
That all said, how much does it matter that we do not have a crystal ball when thinking about risk factors for the year ahead? Wealth managers and advisers help their clients to invest for the long term, in line with their risk tolerance and goals. They understand that different asset classes perform well at different times, and construct portfolios accordingly. If they get that right, drawing on tried-and-tested risk, return and correlation expectations, the different parts of the portfolio work like players in a team. When some are struggling, others step up to take the slack.
It is not yet clear whether inflationary forces will fade in the coming year or whether we are in for a prolonged period of steeply rising prices. Nor do we know whether interest rates will climb gradually, rise sharply or need to be cut again because of some unknown factor waiting around the corner.
Yet a diversified portfolio with a broad mix of global assets matched to a given risk profile is prepared for these eventualities. While traditional fixed income might struggle in an inflationary environment, equities tend to do well as long as companies succeed in passing on their rising costs to customers.
Useful players
Real assets such as property and infrastructure can also be useful players, as rental costs and revenue streams are typically linked to inflation. Indeed, in 2021, real estate, along with commodities – another valuable asset class in inflationary environments – was one of the strongest performers.
Of course, these relationships may not play out over short periods. The drivers of performance of individual sectors, asset classes and markets are complex and various. Over the long term, though, markets are driven far more by structural factors – geopolitics, demographics, technological advances – than by tactical risks.
Whether inflation will ultimately prove entrenched or more transitory, I will therefore leave to the economists to debate. My prediction for the year ahead? Globally diversified multi-asset portfolios matched to a given risk profile will be best placed to weather whatever might be in store. The right team beats a crystal ball any day of the year.
Ben Goss is CEO at Dynamic Planner