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The macroeconomic environment that has underpinned the global financial markets for the past 25 years is clearly transforming, with potentially profound implications for how investors should think about asset prices and market structures. Indeed, we believe this reshaping of the macro landscape — nothing short of "regime change" — is likely to challenge (and maybe even overturn) many of today's long-held investment assumptions.
Nowhere is this more true than on the global inflation and interest-rate fronts. The so-called "easy money" era — a multi-decade period marked by historically low inflation and ultra-accommodative monetary policy — is over.
Structural global inflation is at the root of our "regime change" thesis. In fact, we have been steadfast in that conviction for more than a year now, even as the market and central bank consensus was suggesting that resurgent inflation was merely "transitory." Our 2021 research concluded that going forward, inflation was likely to be stubbornly higher and significantly more volatile than expected. Some, though not all, of the longtime catalysts of low and stable inflation are now more or less in reversal. Namely, we are seeing tectonic shifts toward less globalization, greater regionalization, and a new set of political objectives (including decarbonization) that will require more activist fiscal policy — policies that we believe are more apt to generate higher inflation than stronger trend growth.
Broadly speaking, the global macro environment from here is likely to be somewhat reminiscent of that in which the capital markets operated pre-1995 (rather than post-1995). A striking feature of much of the past 25 years is how tame macroeconomic volatility has generally been, in terms of both GDP growth and inflation, despite some major recessions along the way (Figure 1). We think we are returning to a world where GDP growth and inflation are going to be more volatile, similar to what we experienced from the mid-1960s to the late-1980s. During that period, economic and business cycles tended to be more frequent and more pronounced.
Of course, over the past two decades-plus, there have been several times when systemic financial stability was compromised by built-up market imbalances and excesses — most notably, the 2008 global financial crisis. However, these transitional periods have typically been short lived, as the US Federal Reserve (Fed) and other world central banks simply ramped up their super-accommodative monetary backstops to contain the damage. As a result, real interest rates grinded ever lower and the economic cycle reverted back, relatively quickly, to "healthy growth with low inflation." A key takeaway from our analysis: Over the past 25 years, most global economies have spent on average 31 consecutive months in the "growth but little inflation" phase of the cycle. Figure 2 is a color-coded visualization of the dramatic shift to relative cyclical stability that began in the 1990s.
It is impossible, in our view, to overstate the role that this limited cyclicality has played in defining asset returns and market structures over the past two-plus decades. For example, it has helped fuel the technology sector's relative dominance, as less cyclical volatility meant less risk associated with funding high-growth, high-"cash-burn" business models. It has undergirded the meteoric rise of passive investment strategies: The more central banks suppressed volatility, the more they stifled dispersion and opportunities within asset classes and across regions, making it more difficult for active managers to outperform. And it has incentivized capital concentration in top-performing assets, especially US assets, because from less cyclical volatility came more reliable market leadership.
Now, persistent global inflation and tighter monetary policy are poised to severely challenge those status-quo dynamics. As we noted recently:
So, what does all of this mean for asset allocators? With macro regime change still in its early stages, a precise answer is unrealistic at this point. Moreover, greater cyclicality will translate to greater need for strategic flexibility on the part of allocators, meaning that the answer may be different at each stage of a given cycle. That being said, at a 30,000-foot level, here are five key pillars of our investment thinking as of this writing:
Evidence continues to mount that a seismic global shift is underway that will disrupt the macro dynamics of the past two decades-plus. We believe asset allocators should consider taking appropriate steps to adapt their portfolios accordingly.
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