Investors should prepare for the old normal to flare-up as seen in the 1970s of entrenched inflation and short, volatile market cycles, according to Wellington Management macro strategist, John Butler.
Butler says in a recent note that the last two decades of mostly benign economic conditions of almost no inflation in either growth or flat-to-negative periods was likely an historical anomaly.
Despite signs central banks may soon ease amid apparent disinflation, he says underlying trends of deglobalisation and a shift of income towards labour suggest markets need to brace for a reprise of the 1970s “and to a lesser extent, the 1980s”.
“It might feel and sound like last year was the aberration, but I would argue that in fact the previous 20 years constituted the unusual period and investors can learn a lot more about where we’re heading by looking at the 1970s,” Butler says.
Structurally higher and more volatile inflation would complicate monetary policy decisions with the balance likely tipping towards recession-aversion over constraining price rises.
“This new paradigm has unsettling implications for asset prices and the correlation between assets,” he says. “In particular, with cycles becoming shorter and more volatile, the correlation between equities and bonds is likely to fluctuate, thus reducing bonds’ reliability as a hedging asset in multi-asset portfolios. Asset prices also will have to adapt, and I foresee much more differentiation between countries and even sectors and companies.”
However, Butler suggests markets have yet to fully price in the “regime transition”, setting the scene for more volatility as reality hits home.
While investors today might face different challenges than 1970s counterparts – such as an aging population and climate change – the era-in-waiting will have a “distinctly retro feel”.
Despite the difficult economic backdrop, especially compared to the previous 20 years, Butler says change will also bring opportunities.
“I’ve been in global markets now for 30 years and this is the most complex macro environment that I’ve lived through, but it’s also the most exciting,” he says.
For example, Butler says growth will probably “surprise on the upside”. Although the real, ex inflation, growth might be low, “it still may translate into attractive investment opportunities”.
“However, to succeed in this new era, I believe investors need to really understand where we are in the cycle and have a handle on the implications of the broader macro backdrop for their portfolio positioning,” he says.
Investors will also have to remain nimble to negotiate through shorter and more volatile market cycles.
As well, Butler says an expected “greater divergence between winners and losers” will mean an “in-depth knowledge” of companies and debt issuers will become “more crucial than ever” for investors.
Founded in 1933, the Boston-headquartered Wellington is one of the oldest fund managers in the world. Wellington is also the underlying manager for the sustainable international equities and global bond funds offered by Devon.