Inflation (Part 47)

PUBLISHED Nov 29, 2022, 11:07:09 AM        SHARE

imgChimp Investor Blog

If you enjoy reading this blog, please leave a star rating on WealthTender. Thank you!

Some thoughts on this most important of issues following participation in a Citywire roundtable

I was kindly invited to join a Citywire Roundtable recently. The idea for the discussion had been sparked by global chief investment strategist of BlackRock’s Investment Institute, Wei Li proposing a replacement for the 60/40 portfolio, as reported in the article 60/40 or 30/30/30? BlackRock forecasts renewed focus on asset allocation mix (someone's maths looks a tad dubious). However, it was essentially a debate about asset allocation in general.

Let's address Blackrock's idea first. What Li is proposing is that instead of a static 60/40 allocation to equities/bonds, long-term/retirement savers should have a static 34/33/33 (phew on the maths front) allocation to equities/private markets (presumably private equity but possibly a combination of private equity and private debt)/bonds.

Frankly, in my view, tweaking things this way is like rearranging deckchairs on the Titanic. The issue here is not the mix but whether the allocation is static or dynamic. Systematic real returns from both equities and bonds until a couple or so years ago had been fantastic (roughly 8% per annum each) for the best part of four decades. These returns were never sustainable (why on earth should you deserve such a high real return for lending to an advanced country government?!) and we may well now be entering a multi-decade period in which systematic returns are very poor (in the US, from 1965 to 1981, systematic real returns from equities and bonds were, respectively, -1% per annum and -5% per annum).

With such poor systematic returns, there is not a single static allocation on this planet that is going to work. In other words, generating decent returns for the next several years, perhaps even the next decade or two, is going to be about alpha not beta. Moreover, given the amount of alpha that needs to be generated to compensate for the vastly lower beta, a high conviction approach is required. A high conviction approach could pertain to selection (to particular equities etc) or to asset allocation (to particular asset classes/geographies/sectors etc). My specialism is asset allocation, so my approach relates to the latter.

In terms of the Citywire debate, inflation played a starring role, as indeed it should have. Inflation is the key determinant of real returns (over time frames > 5 years) from equities, bonds, property, precious metals etc. i.e. everything. Importantly, inflation is cyclical. It is cyclical over 4-6 years (business cycles) and it is cyclical over 40-50 years (debt cycles). Furthermore, if inflation is cyclical, as indeed it is, it is predictable. And if it is predictable, active asset allocation can add value to a retirement/long-term investment portfolio.

Whether among the investing public broadly or among the panelists, it seems to me that there is not yet a sufficient recognition about the threat presented by persistently high inflation. Either 1965 to 1981 is so long ago that it does not get incorporated into thinking/models, or there is a feeling that the world economy is now able to withstand the forces that have in the past led to persistently high inflation. Also, among the panelists, there was a prevailing belief that the high inflation over the last couple of years or so was the result of exogenous shocks, namely covid (supply issues followed by excessive monetary/fiscal policy) and Ukraine (energy, food prices).

My view is that these events were not the causes of the high inflation but catalysts. Given the stable/falling inflation environment we had enjoyed for four decades, a multi-decade period of high inflation was inevitable. All that was needed was a catalyst or two. Could have been a pandemic, could have been a war. Or a meteorite. Or a major internet outage/cyber attack.

The below figure is from the paper The Burst of High Inflation in 2021–22: How and Why Did We Get Here? and it shows just how stable inflation has been in recent decades in the UK (the author considered 20 year blocks starting in 1217 so the figure does not quite capture when periods of high/low/rising/falling inflation started and finished. However, one can discern the three periods of persistently high inflation in the 20th century in the bottom right).

Figure 1. Eight Hundred Years of Inflation in the United Kingdom, 1217 to 2016

img Source: The Burst of High Inflation in 2021–22: How and Why Did We Get Here?

There also seems to be a view that given the increasingly widespread predictions of recession, markets should have already anticipated such. That they haven't, some argue, means the predictions are wrong.

My view on this is that things happen slowly and it can take a while for tipping points that cause unemployment to rise (the key recession indicator, albeit a lagging/coincident one) to be triggered. People are still running down savings so consumption has held up. Or at least held up to the extent that companies are yet to start shedding labour systematically (I recall the fears of subprime causing a recession years before it did).

Indeed, I hear people say, but surely all the talk of recession should have caused some sort of reaction in financial markets? They are, after all, discounting machines.

Not necessarily. Some things are impossible to discount, even if they are inevitable (we do not feel the full force of grief relating to the inevitable passing of an elderly parent before the event, only after). Markets respond to tighter/looser liquidity, they cannot fully anticipate it. Markets respond when tipping points are reached, not before.

Perhaps a recession is not quite inevitable but the currently inverted yield curve - a reliable predictor of recession - in many countries suggests the probability is high.

Finally, we must remember that high inflation continues to erode the real value of equities, even if it is starting to show signs of decelerating. So, a 5% increase in nominal terms could well be a 5% decrease in real terms (remember, this has not been an adjustment we needed to make in the last forty years). In other words, it may be that poor-ish real returns are indeed starting to discount a recession, rather than decent-ish nominal returns that are not.

The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.

© Chimp Investor Ltd
Originally Posted in Chimp Investor

Sound investments
don't happen alone

Find your crew, build teams, compete in VS MODE, and identify investment trends in our evergrowing investment ecosystem. You aren't on an island anymore, and our community is here to help you make informed decisions in a complex world.

More Reads
Warren Buffett Stocks: Louisiana-Pacific Corporation

Louisiana-Pacific Corporation (LPX) is a leader in high-performance building solutions. The company manufactures engineered wood building products for builders, remodelers, and homeowners across the globe.

The Safest Utility Stocks to Invest in Q4 2022

We found the top 5 safest utility stocks based on volatility, drawdown, dividend policy, and dividend cuts. Why are utilities safe? We'll explain why.

7 High Return-of-Capital REITs

Real Estate Investment Trusts (i.e., “REITs”) are tax-advantaged income vehicles that have become increasingly popular with investors and institutions in recent years.

November 2022 Stock Considerations

With a new trading month already in full swing it is time, once again, to highlight some of my potential stock purchases.

Skyworks Solutions (SWKS) Stock: An Undervalued Chipmaker

Over the past five weeks, the market has been up 14.7%. Also, after the CPI report was issued last Thursday morning, the market and almost all the stocks had a tremendous run-up. In two days, the market is up nearly 7%.

2 Recession-Proof Utility Stocks With Safe Dividends

The Fed has raised the Fed Funds rate six times this year to combat inflation and the last four times at a 0.75% clip. The current 4% rate is the highest in well over a decade. But the Central Bank has indicated that it will take more pain to get that inflation genie back in the bottle.

WestRock (WRK) A Dividend Stock Comeback Story

Yes, this is a random WestRock (WRK) dividend stock, come back story. Why is it a comeback? WestRock decimated their dividend during the height of the pandemic from COVID-19. One of the world’s biggest, packaging companies reduced their dividend to $0.20 per share, per quarter from the high of $0.465.

AEP to Focus Capital Investments on Regulated Businesses, Reaffirms Operating Earnings Growth Rate of 6 to 7 Percent

Reaffirmed 2022 operating earnings guidance range of $4.97-$5.07 per share and midpoint of $5.02; 2023 operating earnings guidance range of $5.19 to $5.39 per share; Five-year, $40 billion capital plan emphasizes investment in wires and renewables

Southern Company - A Buy but Not Without Risks

We assess Southern Company to be a buying opportunity. For retail investors, this may be a good time to dollar-cost average into a position in SO.

Dividend Kings in Focus: V. F. Corporation

V.F. Corporation is a giant in the apparel industry. The company’s annual sales amount to nearly $12 billion, but the company has humble beginnings. It started all the way back in 1899 and has seen many twists and turns in the 123 years since.

October 2022 Passive Income Update – Lower Dividends, Higher Passive Income

The market decided to climb back up this month and then interest rates rose once again. The narrative hasn’t changed both Tiff and Powell have said they aren’t done raising interest rates in previous hikes. Unfortunately Tiff played his cards first hoping Powell would follow suit with a .5% raise and the US raised theirs .75% essentially devaluing our dollar. Inflation for Canadians should rise on this move alone as it now costs us more to buy stuff in usd.

Procter & Gamble Stock: Recession Resistant Dividend Aristocrat

When volatility grips the stock market, as it has this past year, income investors should focus on quality dividend growth stocks.

Dividend Income Summary: Lanny’s October 2022 Summary

This is what dividend investing is all about! Investing in dividend stocks allows YOU to earn dividend income, the best passive income stream! Bias, you better believe it.

10 Compelling ESG Stocks That Pay Dividends Now

In the world of investing, the goal is always to compound wealth as efficiently as possible. We think the best way to do that is to buy high-quality dividend stocks, reinvest the dividends, and stay the course over a number of years. However, investors can also infuse their own personal preferences or beliefs into their investing strategy, and still make great returns.

What are the Dividend Policies of the Top Utility Stocks

When an income investor researches utility stocks, the dividend policy is an important decision factor. Here are the dividend policies of the top utility stocks and what they say about the stock.

AMC Stock Forecast, Analysis, Price & News | Is AMC stock a buy

Based on the stock performance over the previous 8 years, AMC has traditionally increased by 80.5% during the following 52 weeks. Learn more!

Is Planet Fitness a Buy or Sell? PLNT target price

Based in Hampton, New Hampshire, Planet Fitness (NYSE:PLNT) is an American fitness facility franchisor and operator. Let's explore it!

Are we in an Index Fund Bubble?

Are we in an index fund bubble? Should you stay the course and keep investing, or should you sell and look for better opportunities? As with most things there is no one size fits all answer. The markets are in a state of turmoil, so it is easy to see why one would think that avoiding certain asset classes might be a good idea. Let’s take a look at index fund investing so you can see if it is right for you.

Dividend Stock Watch List: Lanny’s November 2022 Edition

Welcome back to another dividend stock watch list article! The stock market is still down almost 19% year-to-date, but the last full week of October there definitely was a big push!

Is Verizon a Good Dividend Stock?

Despite the recent uptick, the bear market is still growling in 2022. The Nasdaq and S&P 500 Index are down more than 20% each, while the Dow 30 is doing somewhat better. Consequently, many high-quality stocks’ stock prices have also declined, along with valuations. One such stock is Verizon Communications (VZ), trading near its 52-week low and the lowest price in a decade. But is the stock a value trap, or is Verizon a good dividend stock?

Resources for Publishers
Resources for New Investors
Boosted with BossCoin
Financial Literacy Leaders
Tom Hamilton
Wise Intelligent
Mark Robertson
Kevin Matthews II
Akeiva Ellis
Brendan Dale
Kenneth Chavis IV
Sharita Humphrey