Interest rates

Inflation and interest rates are going to be higher than…

In the 1970s, we saw oil price shocks – we have oil price shocks right now; the 1970s were characterized by social unrest and conflict – we have that now; and the US Federal Reserve ran very loose monetary policy for too long in the 1970s, which mirrors exactly what we see today.

It should be noted that the Fed’s approach to the 2008/2009 global financial crisis, and more recently the 2020/2021 COVID-19 pandemic, directly contributed to higher inflation rates. The Fed has kept rates low for too long while pumping record amounts of liquidity into the system. Importantly, their balance sheet has grown from US$1 trillion to US$9 trillion over the past 12 years; this money fueled the economy and created asset bubbles and excess demand in the system.

The consequence of this central bank largesse is that inflation and interest rates are going to be higher than they have been in most investors’ lifetimes.

At present, interest rates in most countries are well below levels of consumer price inflation. If central banks want to bring inflation down, they need rates to be much higher – therefore, we expect the US and other developed markets to raise interest rates significantly relative to current levels, which will hit segments of the market hard.

Investors have already suffered the shock of rising interest rates during the sharp drop in stock market valuations over the past six months. Global stocks are down 20% in the first six months of 2022t, while the tech-heavy NASDAQ is down 30%, making it the worst half year open for markets in more than 50 year.

Now, we talked a lot in 2021 about how expensive stocks are, so we expected them to pull back, especially tech stocks. What surprised us, however, was the pace at which these events unfolded, which speaks to how quickly world events are transmitted through markets these days.

With respect to the impact of geopolitics, this theme is best described by the title “East wins, West loses”, as there is already ample evidence of a global shift of power from the United States to China. This can be seen in China’s leadership in the technology race, its emerging dominance in the space race, and the investment of US$8 trillion in infrastructure projects through its initiative. “the Belt and the Road”.

We are heading into a decade of exponential tech development, and while tech stocks have recently suffered a strong sell-off, there are few signs that the underlying pace of tech investment is slowing down. Exponential growth, both in technology and in its adoption, remains the backbone of what’s happening in the industry. What makes this decade so exciting is that so many emerging technologies are growing exponentially and converging with each other to accelerate each other’s growth. This translates into a continuation of surprising technological impacts on our daily lives for years to come.

So how should investors adapt to higher inflation and higher interest rates, as well as position their portfolios to take advantage of geopolitical shifts and future exponential technological improvements?

Gold still stands the test of time as a hedge against inflation and remains a popular store of value in times of turmoil. Other inflation hedges include real assets such as forestry, infrastructure and some real estate investments as well as inflation-indexed bonds.

But the theme of Chinese domination is more difficult to expose. It is complicated to invest successfully in a communist economy. Instead, look for companies that serve China and its growth in Asia in countries with more predictable governments and capitalist models.

As for technology, the recent market sell-off creates opportunities to invest at more reasonable valuations. We continue to be on the lookout for a range of potential investments that will leverage the exponential technology theme, from biotechnology to cloud computing to quantum computing and, of course, the metaverse. DM/BM

Author: Hywel George, Chief Investment Officer