“The big problem for many investors at the moment is that the information they accumulated during a quarter of a century of global disinflation is just not relevant any more,” says CLSA strategist Russell Napier.
Not since the 1970s have investors had to cope with the prospect of major inflation, exchange rate depreciation and higher taxation – the “well-documented responses by elected governments to high and rising public debt levels.”
Only a few investors – those now at or above retirement age – have any practical experience of how to adapt in such an environment.
A whole generation of investors have been taught in hundreds of business schools that markets are efficient. That hypothesis is now discredited. Yet because of its long dominance of investor thinking, the “lessons from the pre-disinflationary era are not yet priced in.”
Napier thinks it very unlikely that elected governments will be able to take us “seamlessly to higher inflation and thus apparently ease the public debt burden.
“One must expect a rearguard action by the central bankers and, depending upon their stomach for political and social unpopularity, another brush with deflation may yet be on the cards. However, central bankers will lose such a battle, as they have done before.”
Napier suggests investors will need to hold more assets outside their own countries as governments in dire straits can depress returns on a very wide range of domestic assets.
Asia should be particularly favoured as the “new inflationary wave will transfer wealth from the producers of goods in the West to the producers of goods in the East.”
Their banking systems remain strong and government interference in capital allocation has remained unaltered during the present crisis. “The East will become increasingly attractive to free-market capital as Western governments become mired in the capital and wealth allocation business.”
Last year, for the first time, the developing world consumed more energy than the developed. And this year the advanced economies of North America and Europe will generate less than half of global output.
“The emerging markets have come of age,” says investment adviser Tim Price. In many respects they have better fundamentals than the West – better growth prospects, larger foreign reserves, less sovereign indebtedness, better GDP per capita growth, a stabler banking system, superior household finances and savings rates.
Where to invest
What matters now is not where stock markets are heading, but identifying quality shares with sound fundamentals and fair valuations for businesses that can be expected to weather the recession better than most, argues UK investment adviser Tim Price of PFP Wealth Management.
“Defensive stocks have hugely lagged this rally, but that is no reason to ignore them. And for investors with the risk appetite to suit, mid cap value stocks – again, with sufficient cushion against recession by way of balance-sheet strength – offer compelling growth potential.
“But the real elephant in the room… is the vast potential of Asia.
“The most attractive sector of the global debt markets is that relating to the most creditworthy sovereign issuers – countries, and corporates within them, that are inherently solvent rather than bankrupt.
“In equity market terms, Jeremy Grantham [the well-known investment commentator] rightly points out that ‘growth’ countries do not necessarily correlate to the best equity performance.
“But during this ‘changing of the guard,’ investors will be hard-pressed to find fundamental reasons to buy knackered, ex-growth, largely insolvent economies such as Western Europe’s, when they can buy healthy, pro-growth, solvent economies in the so-called ‘developing’ world.”
• This article was written by Martin Spring in On Target, a private newsletter on investment and global strategy. Email
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