If members choose from different diversified  options off targeted risk/return  metrics (expected real return targets,  expected volatility, expected negative  returns of one in so many years, etc),  then would this static growth/defensive  asset mix make such risk/return targets  vulnerable?  Since inflation cycles are long lasting,  we would need a database spanning  nearly 100 years to make any sort of  comparative analysis or informed remarks  as to how assets could be expected  to perform under a new inflationary  cycle.

The most comprehensive and  lengthy economic and asset database is  supplied by Ibbotson Associates. This  yearbook has detailed US monthly economic  and market information starting  back around the early 1920s. Rather  than reading too much into this data,  our preference is to assess the direction,  impact, and changes in risk/return  metrics, then relate such changes to  economic theory. The goal here would  be to help ascertain any similar impact  were we now in the midst of a secular  shift in the inflationary regime. 

Disinflati on  If one considers inflation as a tax  on the real value of our assets, then the  most enviable inflationary environment  would be disinflation. Disinflation refers  to a drop in annual inflation figures.  Although still positive, the level of inflation  drops year-by-year, thereby delivering  higher real asset values off a positive  economic and profit environment.  For our purposes, we equate the  start of disinflation to the end of 1981,  when the then head of the US Federal  Reserve made a determined push  against the then prevalent high inflation. 

Monetary policy was tightened,  with short-term rates pushing above  14 per cent. The impact from this was  a temporary hit on economic growth  and corporate profits, but a permanent  blow against inflation. Whilst secular  inflation fell by nearly 75 per cent from  previous peaks, all the major asset  classes benefited from this new, more  manageable secular regime.  Aside from having the highest nominal  and real long-term returns, these  high returns similarly had the lowest  volatility. The market corrections that  existed during this period were short  lived as the asset bull markets eventually  returned to their upward trend. Any  short-term correction proved to be a  buying opportunity for the medium  term investor. In addition, the correlations  amongst the major asset classes  were highly positive, around 0.75 or  more.

Therefore, the disinflation period  has by far been the most rewarding  to asset owners, be it in nominal or  in real terms. Not too surprising,  therefore, that asset owners sought to  increase their wealth through leveraged  exposures, where borrowing rates were  below actual returns delivered.  Whereas Disinflation benefits  asset owners, inflation uncertainty has  the opposite effect. The two worst  inflationary regimes are “Deflation” and  “Rising Inflation”. Deflation refers to  negative inflation, where one buys assets  cheaper tomorrow than they can today.