Investment “rules of thumb” are being called into question as global markets move into a “very different environment” of high inflation and constrained central banks, says Bridgewater Associates senior portfolio strategist Phil Dobrin.
Dobrin told Investment Magazine’s Fiduciary Investors Symposium last week that investors will need to diversify to help protect themselves from falling growth and rising inflation.
“Policymakers and central banks, in particular, are going to be forced to choose between abandoning their inflation target or cracking the economies and markets, and that’s a very, very tough choice,’’ Dobrin said in his presentation: ‘a new paradigm and what investors can do about it’.
“It’s a hard environment to invest in and it’s one where you can get pretty different outcomes depending on the choice that’s made, which speaks to the need to diversify.”
Dobrin argued that the outcomes we’re seeing today started with the massive policy response to the Covid-19 pandemic in 2020 and the subsequent misdiagnosis that the inflation in 2021 was supply-related.
Policy to Covid triggered a demand shock
“The policy response to Covid triggered a demand shock in 2021 that masqueraded as a supply shock, and therefore was mostly ignored. In 2022, the war in Ukraine brought the supply shock everyone had been talking about in 2021 and layered it on top of the existing demand shock,” which has forced “a massive shift” by central banks to tightening.
He said that he expects policymakers to ebb and flow between painful interest rate hikes to bring down inflation and doing what they can to avoid the pain associated with bringing inflation back to the 2 per cent target.
“Are they willing to see equities fall another 20 to 25 per cent from here? Are they willing to see the unemployment rates start to rise? Or, when faced with those things, are they actually going to – as they did multiple times in the 70s – relent,” Dobrin said.
“If you look at the reason that some of the most reliable market relationships have broken down, it really comes down to how the world is very different in an environment of persistent high inflation and where central banks are constrained.
“(Central Banks) in the US, Europe, UK, Australia, (are) unbelievably constrained. Japan a little bit less constrained … China actually does have much more ammunition but they’ve got a whole set of other problems that they’re dealing with, which makes China quite interesting to investors looking for diversification.’’
He also explained that portfolio managers can make some adjustments to equity-correlated portfolios by picking some “low hanging fruit”, such as shifting some nominal bonds and fixed income assets towards inflation-linked bonds and inflation-indexed cash flows.
“In equity markets there’s a lot of room to build either more defensive and resilient equity portfolios, particularly if you have some cross asset hedges. There’s also room within liquid and illiquid portfolios focused on cash flow to think about how to structure a portfolio where cashflows are both more resilient in the face of falling growth and more contractually indexed or reliably participant in the rise of inflation,’’ Dobrin said.
Investors need to think about the strategies that offer protection in an environment characterised by surprising shifts in the rise and fall of both growth and inflation.