‘It takes a long time to turn a super-tanker’ – this pithy adage is one that often sits somewhere just beyond conscious formulation in minds across financial markets. The uncooperative disconnect between many macroeconomic unfoldings and the time horizons in which market participants often think and act is a source of much of the uncertainty. This lack of timely confirmatory feedback sustains the jerking, jarring hyperbole of competing views that pepper financial commentary, feeding the uncertainty itself.
Now – what if a tanker of historic proportions, loaded to its height with global cargoes, is blown by some sideswiping contagion of winds and becomes stuck across a vital bottleneck – the Suez canal comes to mind? In some ways this is how the current environment feels, with market participants scrambling to understand the macroeconomic and inflationary implications of a pandemic event on a scale with little historical precedent.
The fragilities of global ‘just in time’ logistical supply chains, blocked by persistent bottlenecks in the aftermath of the brutal squalls of Covid-induced economic shutdowns. Persistent demand and supply imbalances accompanying re-openings after an almost as brutal ‘all hands on deck’ approach of monetary and fiscal authorities, who sought to plug holes in demand and protect supply. And all alongside an incredible scientific response in vaccine development.
Investors are searching for close precedents and finding few. Perhaps they are dusting off literature about 1970s stagflation, its claimed causes and cures, and trying to understand the significance of the similarities – and the differences – between then and now. Instances would include the sheer pace of technological advance, associated monopolistic characteristics in global economies, changes in labour bargaining power, deglobalisation and decarbonisation.
To what extent can the incessant, swarming tugs of central banks, pulling and jerking on their towlines, affect the trajectory, before their lines snap under the strain? Can addressing infrastructure help, digging away at the sandy banks of the canal and so increasing overall productive capacity?
Or perhaps, in extremis, will draining the tanks of fuel be necessary to unburden the load and refloat the vessel? We are hearing talk of unified releases of strategic oil reserves from the US and China, while the Biden administration has negotiated for the two key distribution ports – already accounting for 40% of all containers moving in and out of the country – to move to 24/7 operation, almost doubling capacity. Actions and reactions.
What will have changed?
Finally, once the vessel is eventually unstuck and the bottlenecks drained, will it actually have turned, or will it simply plough forwards on its previous course? Once the shock and the violence, the confusion and disruption of the Covid-19 pandemic finally fades, what has really changed from the 2008-19 period of stubborn below-target inflation? Is it enough to herald a new inflationary backdrop?
The world had been struggling for decades with a gnawing worry – persistently low inflation and the threat of deflation; proclamations of ‘secular stagnation’. It was broadly acknowledged below-target inflation posed more of a threat than above-target inflation – monetary authorities have the tools and playbooks to deal with above-target inflation, but low inflation required broader fiscal responses that governments, given orthodoxies of the time, avoided in the main in pursuit of selective formulations of debt sustainability.
Staring now down the possibility of a shift, however, many investors worry about complacent authorities allowing inflation to take root, then needing to step hard on it – raising rates and choking off economic recoveries – in the face of markets trading at lofty prices after decades of falling rates and stimulus.
On balance we still feel an extended but temporary trajectory of higher but manageable inflation is likely, and it is harder to see the conditions for a spiral – and it is the continuous rise in prices, not one-time shifts, that is key here. This is what central banks maintain, as well as most intra-governmental institutions such as the Bank of International Settlements and the International Monetary Fund.
Even the key market-based and survey-based measures, when looking beyond the near term, point to a subsidence back towards the higher-end of central bank targets – which, given the previous worries about deflation, would probably be counted a success.
That said we are in territory that has been charted only sparsely and, as we know, inflation can be the scourge of nominal assets, corroding their value over time. For the strategies we run, where the primary goal is to achieve inflation-plus returns, we allow wide flexibility to shift asset allocations to achieve this – and, in the face of such an uncertain range of potential outcomes, we feel this focus and flexibility is key.
Even with such tools, however, the greatest challenge is to stay calm and acknowledge these broad macroeconomic processes take time to emerge and for their implications to be understood – and it is important to look through the short term, try and filter out the noise, and remain patient until the overall trajectory becomes clear.
Life and markets are full of overlapping and interacting cycles. There is violence in the second hand of a clock; paying some sustained attention, we can see the minute hand shift; while the hour hand’s movement is imperceptible, turning its wide arc like some super-tanker. Only by averting our gaze and letting the day play out will the passage of time become evident – like sand through the bottleneck of an hourglass.
Edward Fane is head of research at Morningstar Investment Management EMEA