There are some positive outcomes in a recession
Just like the weather in Australia, no two days are ever really the same. The same could be said for investing. Six months ago, global central banks were discussing the nature of inflation being "transitory" with certain factors like supply chains and stimulus spending set to wear off.
Then, in March, the Federal Reserve pulled the trigger on a 25 basis point hike flagging more would be on the way. The first Tuesday in May saw a similar fate for the Reserve Bank with the same conclusion - more hikes will be needed to rein in inflation.
Anthony Golowenko and the team at MLC Asset Management have been warning clients about the dangers of rampant inflation for months. In this latest episode of Expert Insights, we probe him on the team's latest views around what inflation could do to the global investing landscape. Should investors fear the R and S words (recession and stagflation)?
Watch the video or access our edited transcript to find out.
LW: How likely is a recession within the next two years?
Anthony Golowenko: The inflationary environment, and let's not forget, we've come through pretty difficult times and the health recovery, the efficiency of vaccines, and now definitely economies are on a much firmer footing.
Within our Investment Futures Framework, we have a range of inflationary scenarios. And probably as simple as that can be, the inflationary sort of nominal growth skew is real. Part of that soft landing, if you like, means inflation can be accommodated, and it's broadly under control, and we see an opportunity for equities to do reasonably well as valuations can be constructive.
Now I'll classify that as a soft landing. Within a soft landing, a modest or mild recession, given the two years and 10 years we've had, that's totally okay. So within that inflationary, nominal growth skews real, and in that softer landing, a mild recession, I think is something investors should be prepared for.
Where we could be going, and probably the more concerning aspect in this nominal growth, skews inflationary. So inflation effectively eats up that growth. It makes it more difficult for earnings, more meagre results, and lower valuations. That's something obviously is front of mind for us as a concern, but part of a broader complexion of inflation.
One of the elements of our Investment Futures Framework is that we're not interested in a single point or a single narrow range of cases.
It's really about positioning our portfolios for resilience across a broad range of potential future outcomes. And in thinking about the likelihood of stagflation at this point in time, it's certainly possible. From a consumer standpoint, and an inflationary standpoint, ultimately food, shelter, fuel and energy, and then into healthcare. So of those components, certainly energy costs are elevated and in places like Europe and the UK as importers of energy, without an ability to effectively navigate that while committed to renewables, I think they have less flexibility than in Australia and the US in this environment.
LW: Are markets ready for the policy tightening to come?
Anthony Golowenko: The tightening or required tightening we've started to see. The actual rate rising program, we're only just at the very start. So looking through that, and I'm fortunate that MLC Asset Management in that we have both an equity and fixed income background. I'll give credit to the fixed interest background and credit team for a multi-dimensional view of what could go wrong. I think we've seen repricing pretty markedly in yield curves ,in fixed interest instruments, and more opportunities are there. So credit where credit's due, they do a very good job there.
Equities can do a good job of that, but often it's about optimism. A multi-dimensional view of what could go right - and that's simplifying or trivialising. Having diversity within our teams, diversity within our debate, and constructing portfolios in that way.
I think equities are and can do that. The extent to which earnings and growth fail to be delivered, I think there's another valuation element to come within equities.
LW: Is stagflation a possibility for the global economy?
Anthony Golowenko: The soft landing and mild landing, and a recessionary environment, actually can be a good thing for capital and more efficient allocation of capital. The stagflationary scenarios and the, if you like, gobbling up and real difficulty of inflation not being contained does real damage. And does damage to both the real economy and damage to the financial economy.
Over the past 10 years, it's been really a case of the financial economy outperforming. And more recently, we might actually start to see the real economy outperform relative to the financial economy in financial markets.
Stagflation is part of a wide range of scenarios, and the relevance of both stagflation and inflation over the past three to four quarters in our process has increased.
We're not alarmed by the risk of that. We are open to it and positioning our portfolios for both the offence or participation in upside, as well as defence in your like, in diversity and how we can protect our portfolios.
MLC Asset Management's portfolios combine their best thinking on asset allocation with a disciplined investment process - developed over 35 years - that optimises returns and reduces risk. For further information, please visit their website.
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Hans is a content editor at Livewire. He is the lead writer of Charts and Caffeine and created Signal or Noise. He graduated with an economics and journalism double degree from Macquarie University.