We are approaching something of a post-pandemic turning point – and it’s one most investors aren’t prepared for, neither in their portfolios nor their mindsets.
The story to date is well known, writes 7IM’s Ahmer Tirmizi (pictured). While stuck at home with some spare cash, we spent. And because we couldn’t go out, we spent big. So big, in fact, that US consumers managed to achieve 13 years’ worth of spending growth in just two.
That kind of growth leaves a mark. In this case, that mark was inflation, which is running at multi-decade highs in many developed economies.
Many people blame clogged up supply chains, which is a plausible narrative, but it’s not the whole picture. After all, global manufacturing boomed during the pandemic and China’s share of global trade hit all-time highs. In the main, supply chains worked OK; it was surging demand that pushed up inflation.
The employment market also became distorted. The headlines are that wages have risen sharply. But again, look under the surface and the story isn’t that simple.
During Covid, the companies that benefitted from lockdowns hired relentlessly in order to meet demand, such as Amazon which has doubled its workforce since March 2020. Workers flooded into manufacturing, e-commerce and delivery jobs, leaving few for other sectors.
But what happens when the service sector fully reopens, and goods demand slows? These distortions will unwind and goods inflation will fall sharply.
Many retailers thought the boom would last indefinitely, but some of them now report huge levels of inventory. And some of those workers in ‘stay-at-home’ winners will move to other parts of the job market. This will ease pressure on wages across the economy.
But the transition won’t be easy. Central banks are still twitchy. The Russia and Ukraine conflict complicates the inflation outlook and the manufacturing boom will end as those 13 years of compressed demand growth unwind.
So, what does that mean for equity markets?
Generally speaking, equity markets tend to derive more of their profits from goods producers than from service providers, so they will likely come under pressure – as they have already. And where equities go, so does public sentiment.
That will lead to increased talk of recession, as we’re already hearing, which will have real-world impacts. But, remember, manufacturing isn’t the economy, either in the UK, the US, or Europe.
The other parts of the economy are generally in a good place. Savings are still high, housing is robust and private debt levels remain fairly low.
Put together, the world economy will need to unwind these Covid-driven distortions – the tight global supply chains; the surge in goods spending; the record high goods prices; the sector-specific labour tightness; and falling manufacturing.
However, we have never had a pandemic like this before and so there is no playbook. How, then, do investors position themselves amid such uncertainty?
An uncertain macroeconomic backdrop creates uncertainty for equities and bonds, too. And, in all likelihood, the next move for both asset classes will be sideways and volatile, creating a less-than-ideal environment for a traditional multi-asset portfolio of passive equities and government bonds.
But all is not lost. When there is no playbook, it is better to focus on investment identity, rather than investment types.
Avoid expensive equities
If equities are likely to drift sideways, it could be tempting to hold less. But again, we need to look under the surface.
First, we need to look beyond what ‘worked’ over the last decade or so, which has tended to be what has been the most expensive, with US equities leading the way.
However, over the next few years investors will be far better off swapping this exposure for cheaper parts of the market and for companies with robust earnings.
One example is healthcare stocks, which trade cheaper than the market, have stable earnings and whose fortunes don’t rely on the ebbs and flows of the global economy.
Become unashamedly conservative
If a straightforward passive exposure to equities is unlikely to do much, look elsewhere for returns. Right now, we think credit is the way to do that.
European bank debt and US mortgages, for example, have higher yields but are safer borrowers than most others. Emerging market debt is another. The Russia-Ukraine war has spooked investors but most countries within the index have an excellent track record of meeting their debt obligations.
And right now, yields are in the 7–9% range – the sort of returns many equity markets will struggle to generate over the next couple of years.
Diversify and ditch traditions
In a multi-asset portfolio, equities deliver growth over time while bonds make the journey as smooth as possible.
But inflation uncertainty makes it harder for bonds to play that role. Instead, replacing traditional bonds with a basket of alternatives may help keep up when markets rally but also to protect portfolios when markets get choppy.
No playbook doesn’t need to mean no action.
This article was written for Portfolio Adviser by Ahmer Tirmizi, senior investment strategist at 7IM
