US Edition
The world’s oldest classic horserace, the St Leger, is due to take place at Town Moor, Doncaster, on Saturday Sept 16. Punters are looking forward to a race where the odds are being shaken up by last week’s unexpected defeat for the ante-post favourite, Gregory, in his trial at York.
Stock market investors will be looking forward to the race because it traditionally heralds the end of share prices’ summer torpor and a potentially profitable dash toward Christmas.
The FTSE All-Share index has fallen by 5pc (and the Aim All-Share by 11.5pc) since May 1, a turgid effort to which only Hong Kong and China-listed shares are living down.
It is America that is leading the way, with the S&P 500 5pc higher and the Nasdaq 10pc to the good over the same period.
But even the US indices have shed 4pc to 5pc of their value in August and shrewd portfolio builders will know that both benchmarks are still trading below their highs of late 2021, so even here the picture is more nuanced than it first seems.
It may therefore be worth taking a step back to look at the key issue with which stock, bond, currency and commodity markets continue to wrestle, namely whether the outcome of the current environment will be inflation, stagflation or deflation (or the longed-for return to the “Goldilocks” scenario of the 2010s, whereby low growth, low inflation and low interest rates provide a perfect backdrop for both stock and bond markets).
This matters because the two outcomes require different strategic asset allocations across portfolios and different sector and company exposure in the context of stock markets, at least if history is any guide.
Take your pick
It is easy to make the case for each of the four scenarios.
The case for deflation rests on how there is too much debt in the economic system, a situation aggravated by rising interest rates; the advance of price-crushing, productivity-boosting but job-destroying technologies; trade unions’ loss of power since the 1980s; and demographic trends, whereby birth rates ebb at the same time as the population ages (and saves more and spends less).
Thankfully periods of deflation are rare – Britain and America in the 1930s, Japan since the early 1990s – but history suggests they favour cash, bonds and growth stocks (highly prized when there is so little growth about).
The case for inflation rests on more expensive energy as the world transitions away from hydrocarbons to renewables; more expensive labour now wages are growing again, thanks to low unemployment; more expensive goods, thanks to the desire to “onshore”, bolster supply chains and keep jobs at home; and more expensive money, thanks to higher interest rates.
The experiences of Britain and America in the early 1970s suggest “real” assets, such as commodities, are the place to be, along with index-linked bonds and cyclical and value stocks, since inflation means they show strong growth in nominal terms, and there is therefore less reason to pay for secular growth stocks.
The case for stagflation rests on mountains of government, corporate and household debt; interest rates staying lower for longer to make the interest bills affordable; and how that combination keeps alive zombie companies, who hog capital and hold back productivity, rather than wither and release that capital so that it can be used more effectively elsewhere.
This scenario is the rarest of the lot, although the experiences of Britain and America in the late 1970s show how gold did well (central bankers can print money to pay the interest on debt and other government bills, but they can’t print commodities), as did asset-light and debt-light businesses and companies with pricing power – generally defence stocks and consumer staples.
The case for Goldilocks rests largely on faith in central bank omnipotence and a return to the 2010s: central bankers prove able to balance growth and inflation and the world returns to a period of cheap labour and goods (through globalisation), cheap money (thanks to those same central bankers), cheap energy and relative geopolitical calm.
To this column’s mind, Goldilocks is the least likely. It seems unfeasible that nearly 15 years of extraordinarily unorthodox monetary policy, followed by an enormous fiscal splurge during lockdowns, will be followed by a smooth glide path back to “normality” and where we were before.
In this respect, it would be unwise to assume that what worked in the 2010s – bonds, growth and technology and “long-duration” assets in particular – will work so well in the 2020s, even if that is what the US stock market in particular seems to be telling us right now, given the ongoing predominance of tech stocks.
This column’s view is that inflation is here to stay, thanks to more expensive labour, energy, goods and above all money and it will continue to base its stock selection accordingly.
Yes, money too: higher interest rates could be the cause of inflation, not its cure, as they wipe out zombie firms and profitless disruptors to limit supply on the one hand, and boost the disposable income of the previously interest-starved cash-rich on the other.
Russ Mould is investment director at AJ Bell, the stockbroker
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