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Last time, I wrote about the decades-long misallocation of investment that is now unwinding with attendant market carnage. But what happens next? Will we begin to see inflation start to moderate?
Consider what is now happening in real time: pandemic supply-driven inflation is quickly resolving itself. The backlog of orders and delivery times are falling. Shipping costs are also falling rapidly. The global economy is rebalancing quickly as the recovery process broadens out and various sub-sectors adjust.
Even turning to the grand canvas of geopolitics – a key source of inflation this year – supply chains are adapting. Here, let’s not kid ourselves: Global governments are showing that shrewd multipedal political maneuvering can keep cross-border trade booming. For example, the International Energy Agency reluctantly admitted that recent Western sanctions against Russia have had limited impact on their oil output. The country’s current account surplus swelled to a record US$138.5 billion in the first half of 2022, as energy flows quickly re-routed to other countries like India and Turkey. Or, consider that amid increasing U.S.-China tensions, Covid lockdowns and ongoing hefty tariffs, China’s exports have continued to gain global market share, underscoring the attraction of the country’s global competitiveness.
The fabric of globalization has proved so densely woven it has resisted attempts at a full unravelling. Markets are still underestimating the speed and flexibility of the global supply and production response. This will help tug prices lower in the period ahead.
What about demand-driven inflation? Here, we anticipate stickier conditions. Yes, growth is moderating, which will lower aggregate demand somewhat. But the big surprise over the summer, contrary to widespread recessionary fears, has been global growth that remains relatively resilient, despite rising rates.
Why is this happening? In the 2010s, the need for consumers to repair balance sheets necessitated a far lower interest rate. An extended period of debt reduction, cleansing of excesses, and overall financial system repair was needed. Today, we simply do not have the same economic and financial imbalances. The economy is on far firmer footing, and several dynamics are different: a robust labour market; healthier consumer balance sheets; and a well-capitalized banking system. Interest rate hikes have landed on a white-hot economy, not one balanced on the edge of recession.
Now, heightened demand is convincing executives that capital is worth outlaying – a sign that individual businesses are buying into their own prospects (even as they remain gloomy on the world economy and higher rates). In fact, shortages have quietly kickstarted a robust recovery in capital investment. This was the key missing ingredient in the post-2008 recovery and is crucial for lifting capacity, productivity and, ultimately, stabilizing inflation. Eventually, this will lead to stronger earnings and sustainably higher interest rates, even if growth decelerates for the next few quarters and central bankers can’t stick a soft landing (don’t hold your breath for it).
Make no mistake: Inflation remains a real threat. The pathway of central bank hikes could yet cause more market carnage. But what if, reacting to the liftoff from zero rates, the bulk of the bear market has already occurred? A large market adjustment happened in the first half of 2022, pricing in lower earnings and higher inflation expectations. After the extreme levels of pessimism registered in June, it would not be rare for markets to climb the proverbial “wall of worry” from here. The bar has been set low to deliver positive surprises.
Yet there is a glaring dynamic in today’s market positioning. Investors, still enamoured with the narrow leadership of the last decade, continue to “buy the dip” in U.S. growth and tech stocks and, mind-bogglingly to us, government bonds in the West. The real issue is that most investors remain anchored to the secular stagnation period after 2008. In other words, most simply do not believe we can ever escape low interest rates. And so, the world capital of hot money remains in the perceived safest country – the U.S., a region where a decade-long tear in the 2010s has led to lofty valuations and a swollen share of global stock market capitalization of over 60%, from a low of 45% (and, a level far above its roughly 25% of global GDP).
Comparatively, many investment classes that had struggled with chronically weak demand and dismal pricing power in the era of low inflation are primed for outperformance: international value stocks which trade on far lower multiples and far higher dividend yields; select resource-exporting emerging market equities; and global sectors with pricing power (banks, industrials, healthcare).
Investors should feel relief with all of this. Having wandered through a desolate landscape of low yields over the last decade (feeling like an extra in a Mad Max movie), the world is now normalizing. Higher returns lie ahead – but only if investors reorient portfolios away from those investment classes that needed zero rates to thrive and towards those that have languished over the last decade.
Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. The Forstrong Global Investment team contributed to this article. This article first appeared in Forstrong’s “2022 Super Trends: World in Transition” publication available on Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.
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Content © 2022 by Forstrong Global. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. Used with permission.
The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Performance statistics are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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