French elections and recession worries

Market report

• Government bond yields continued to move higher as investors grappled with the expected evolution of monetary policy in a number of countries
• Stock markets struggled in aggregate with the focus turning to incoming first quarter earnings season
• Corporate pricing power – some thoughts on how to invest during periods of higher inflation

CIO view

An increasingly frantic dance between central bankers and bond investors, locked in their hall of mirrors, continues to mesmerise. The result was longer term interest rates wrestled higher as various notables warned of a steep path ahead for monetary policy.[1] As noted before, there are few coherent signs in the data of the dreaded wage price spiral (where employee compensation and economy-wide prices chase each other higher) just yet. However, the subtext here centres on a necessary admission of ignorance – the mechanisms for how inflation expectations are formed by consumers and businesses remain murky. Our attempts to measure or survey these expectations should not be leaned on too heavily.

The road ahead is precarious[2] of course. From the incoming French Presidential elections to Ukraine, from China’s increasingly debilitating Omicron outbreak to a very unfamiliar cliff in monetary and fiscal policy across much of the developed world, there is much to worry about. A recession is certainly a possibility, even a probability in some areas if certain risks play out as feared.

However, as we discussed in last week’s article, much of this chaotic present should simply be below your eye-line as a long-term investor. Understandably, many become too absorbed by rubbernecking the potential economic prangs ahead. The survival instinct that has helped take us this far as a species can become a debilitating weakness in such moments. Protecting our hard-won savings from all that could go wrong in the path ahead feels only logical – I will just wait for things to calm down a little. Perhaps the passing of French elections, or the prayed-for truce in Ukraine, or maybe another set-back in stocks, the recession everyone is suddenly talking about? Buy the dip always sounds sensible…

The problem here is one of time frames. This industry cannot promise returns. There is literally always something that can go wrong. Most of the really damaging risks from a capital markets perspective are actually those that come without warning or an identifiable calendar date. Those areas where the market glare is already fixed, calculating the range of potential outcomes and fine-tuning the related incentives on offer, from Ukraine to the French elections, tend to be well priced. Not always, however individuals should know what they are up against if they are thinking that some piece of associated market pricing is way out – full-time specialists, focusing on little else but very small subsets of the capital markets universe aiming to eke out basis points of extra performance relative to various forms of competition.

This is why we organise our investment value chain accordingly, teams of specialists focusing on very specific parts of the capital markets world. The bulk of the returns we offer is from getting that core diversified exposure to the longer term wonders of the global economy.

The real trick here is simply getting invested and sticking with it. Make sure that you have that core engine of diversified market access chugging away with our savings over time as a starting point. You can decorate that core exposure with all sort of investment filigree, whilst being sure not to allow the quantity of decoration to dictate the overall direction of returns. Over this longer time frame, it will not be Ukraine, the path of monetary policy or the French President whoever he or she may be that will matter. It will be humankind’s collective ingenuity and resourcefulness, our capacity for invention.

In the shorter term, inflation is the necessary preoccupation of investors. Is it here to stay and what do I do if it is? Stocks with pricing power is the familiar cry. These are companies which benefit from an ability to pass on rising costs to their end consumer, sometimes a function of a captive audience of one sort or another. That corporate super power could well be important in defining the winners of the next period. However, some caution – there is significant overlap between these same companies and those potentially in the valuation firing line if real interest rates continue to rise. Which one of these forces ultimately dominates should not be an area of strong conviction.

More broadly, we should always be wary of buy lists of assets based on basic regressions of the past. This is always a problem of history, particularly when only viewed through statistics – it is not just different this time, it is different every time. There are rhymes and even lessons to be untangled, but this needs to be done with great care and attention to contextual detail. The 1970s contains both of these, but also much that was different. Diversifying for multiple potential futures remains the most appropriate strategy as we head into the fast approaching economic rapids.

[1] https://www.federalreserve.gov/newsevents/speech/brainard20220405a.htm

[2] https://www.hks.harvard.edu/centers/mrcbg/news-events/domash_summers

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