At the start of every year, forecasters cannot help themselves. Forecasts for inflation rounded to a decimal, appear like clockwork. We should know to ignore them by now. Just consider how wrong they got inflation forecasts last year – South African inflation was forecast to be around 4.5% whilst actual inflation turned out to be 7.2%. Even weather forecasts are more accurate these days.
However, and somewhat surprisingly, longer-term trend forecasts are often more accurate.
Here are some of the longer-term trends we believe are intact:
Higher inflation is here to stay
It is unlikely that we will see super-low inflation again soon. Some of the main factors that caused inflation to all but disappear from the largest developed markets (and even caused deflation at times) have dissipated. One of the most important drivers of inflation is labour costs. For decades, wage increases especially in low or middle-income jobs stayed unusually low. However, labour is flexing its muscles. The balance of power is shifting towards labour, away from the owners or capital providers. Watch the rise in labour action all over the world.
Another driver of higher inflation has been energy, which skyrocketed last year. Although energy prices may stabilise or even fall this year, in the long term the price of energy will remain high. A new balance in the production of renewal energy - away from traditional energy sources controlled by unstable superpowers – is needed to change this.
Inflation - which is the rate of change of prices - is likely to slow or even decline this year. This will pave the way for interest rates to stabilise and start declining over the next two years. However, global inflation is unlikely to return to 0-2% soon. This means that long-term interest rates are unlikely to return to their previous lows for a long time.
America is unlikely to shine soon
Over the past fifteen years, the US market dominated returns to the extent that the US market now makes up more than 60% of the value of the global stock market. These returns were driven predominantly by the rise of US global tech companies such as Facebook, Apple and Amazon. The valuations (what investors pay for profits) of US companies relative to the rest of the world are now at a multi-decade high. Investors were lulled into believing that these companies could never disappoint.
But no company can continue to deliver profits at an above-average growth rate in perpetuity. Now that the interest rate environment has changed, these companies are finding it harder to produce the expected profit streams, and investors are no longer prepared to pay premiums for doubtful earnings streams, especially for newer companies. Higher interest rates also result in lower fundamental valuations of future earnings streams, which is now scaring off investors in a more subdued climate.
As for big tech, the law of large numbers, regulators and competition will deliver new winners and some big losers.
In a tighter economic and policy environment, expect the American stock market to deliver below-average returns over the next five to ten years. Countries, like Japan - where policy has been stable, and the economic environment well managed - have been overlooked, but are likely to now attract more investment. Some emerging markets may also benefit.
Worth noting is the potential short-term reversal of this particular long-term trend - the American stock market was worst hit last year, so there could be a rally at some point this year. But do not be fooled into paying top dollar for overvalued and overhyped businesses without solid earnings streams. For die-hard believers in the likes of crypto and big tech, the bounce may give them hope. We believe the environment has changed. It may take time but eventually, hard economic fundamentals will take the shine off big corporate US, especially the big tech winners (those without solid profits) of the last few decades.
Politics is likely to get messier
It is not difficult to imagine a world more polarised and uncertain than it is currently. And it is unlikely to become more harmonious and stable anytime soon. The current model of capitalism and democracy has delivered an unsustainable, unequal distribution of income and wealth within and between countries. As mentioned, labour instability is one result. Another is immigration – people move from poorer to wealthier nations. Accepted liberal values are attacked, and a move to more conservative right-wing politics and even fascism is now seen.
Stable alliances are under threat because values have shifted, and the superpower China has turned more hard-lined. Military spending is also on the rise. Leaders everywhere are disappointingly weak and corrupt.
It all does not bode well for stability and peace.
However, this year, there are no elections in G7 countries or many other leading nations. With elections being mostly divisive these days, this may mean a respite from the heat of global politics. Even in South Africa, we may have less noise. The ANC conference election is now something of the past and it seems that President Ramaphosa is in a stronger position to push through reformist policies (if the Phala Phala scandal does not cancel him out.)
Expect the unexpected
As always, we do not bet on these trends in our clients’ portfolios. The instability has caused many of our sensible investment managers to broaden their investment horizons and diversify more than ever. It has paid off. Our investment managers have also generally avoided hyped areas, where trend reversals can permanently destroy capital.
We must always expect the unexpected. Perhaps this year, early peace in Ukraine could result in the rapid decline of food and energy prices; improved relationships between US and China could boost global trade, or over the next decade new technology could improve productivity to such an extent that inflation will surprise on the low side. These would all be bonuses.
How should we plan around these trends?
Diversify
We have been beating this drum for a long time and will continue to beat it even harder. As always, we do not bet on these trends in our clients’ portfolios. We avoid fads and hype.
Although crypto currency is likely to show better returns as we see a bounce from the extreme lows, some people have lost everything in the scams and fraud. Others have lost most of their capital because they believed that it was necessary to speculate on new investments for capital growth. The easy money environment for speculative investments is gone.
Remain conservative in your spending
This is not a time for exuberance, although I doubt that many readers feel that way. I still notice luxury car sales and new luxury homes being built. In an unstable and unequal distribution of wealth, flaunting wealth will be increasingly dangerous (kidnappings are a rising global concern for the ultra-wealthy), if not unwise. Having a moat of liquidity to protect the castle remains desirable.
Don’t bet on long-term trends reversing soon
It means that borrowing rates may stay higher than expected and economic growth may remain subdued. Arrange your personal life to expect ongoing instability and a subdued economic climate.
Don’t be too pessimistic
In the long-term optimists do better than pessimists when it comes to investments. In a high-inflation environment, pessimistic investors – those who stash their cash in the bank – will reap negative returns after tax and inflation are considered. Investments in riskier assets such as shares or property have a better chance of providing long-term returns.
Furthermore, invest in yourself, your career, and your family. Invest in experiences. Invest in curating your own joyful and positive universe.
And always expect the unexpected.
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