Why the investment cycle is accelerating

The rapid recovery from Covid recessions also means a fast acceleration through the investment cycle this time – here’s what that means for your portfolio.

A bias of value over growth and energy and materials should benefit given higher inflation. Picture: NCA NewsWire / James Gourley

Each investment cycle is different: what has taken me by surprise this time around is the speed with which it is unfolding – especially compared with the Global Financial Crisis cycle.

If we consider the GFC cycle: it was defined by the extreme financial system stress of that time, and ending in early 2009 with global GDP growth for that year at 0.1 per cent, rotating on until the beginning of 2020. It was a longer cycle than normal.

As readers know, the trigger for the GFC was the call-in of US subprime loans and collateralised debt obligations – and a sharp market correction. But what was most striking about the decade following the GFC was its low productivity gains. Global GDP averaged about 3.8 per cent. That was against a background of the US at about 2.7 per cent, Europe at 2.1 per cent and China driving global GDP at 6.5 per cent.

Now, two years after the Covid-induced recession, we see International Monetary Fund projections of global GDP in 2022 of 4.4 per cent, down from 5.9 per cent in 2021 after having contracted -3.3 per cent in 2020.

Considered against the GFC global GDP numbers, these are remarkable figures. What is most striking is that this is happening as we speak – we have already entered what is called “late mid cycle”.

The key issue is policy – set for the early stages of the recovery. That’s because central banks have been reluctant to tighten later into the cycle than is normally the case. They are aiming to get policy settings to a neutral setting – waiting, it seems, for full employment rather than tightening ahead of inflation. An impact of this approach is that they are therefore “behind the curve”.

How have we got here already?

● The first key reason is the Covid-19 pandemic itself and the shake-up it has caused, triggering uncertainty and market disruption;

● The second is the response by both governments and central banks. They responded with fiscal and monetary policies. That has challenged traditional thinking around responding to market disruption and, in some cases, has wrong-footed investors.

While the discussion on inflation is making headlines today, that topic isn’t new. Inflation has been with us for four to five months. However, London analysts Capital Economics recently noted: “We’re at the point where the pressure on central banks to act is at its greatest.”

Inflation, especially in the US, is expected to hold at or around 7 per cent for the next few months. The second half of the calendar year is likely to see inflation decelerating towards 4 per cent.

Cash rates in Australia are factoring in 1 per cent for year end, with 1.75 per cent for the 2023 third quarter (presently 0.1 per cent). Likewise in the US, cash rate predictions are for 2-2.5 per cent for the end of 2023 (presently 0.25 per cent).

There are those who are predicting higher. However, I’d like to highlight the four factors that are highly relevant in our local market:

● Falling inflation – likely to fall over the course of 2022, Capital Economics says, “as energy and goods inflation ease and the immediate inflationary effects of the pandemic fade”.

● Easing supply constraints – as economies reopen, supply constraints will ease, especially in 2023.

● Low rates – neutral real interest rates remain low and therefore it will not take much to cause policy settings to have an impact.

● Evolving monetary conditions – how monetary conditions will affect the real economy is a key question.

So where does this lead us in terms of asset allocation, higher inflation than originally targeted – and robust ongoing growth out of a very strong recovery?

As I suggested earlier, each cycle is different.

Australian equities should do well on a relative basis due to index composition. However, they have lagged developed markets. Australian equities while strong are up only 9.61 per cent over the 12 months to the end of January against Developed Markets (MSCI ex-Australia) up 18.58 per cent hedged and up 27.3 per cent unhedged.

Still, a bias of value over growth and energy and materials should benefit given higher inflation. Emerging markets historically do better in these times. Up 1.03 per cent for the 12 months to end of January, they have also lagged.

In these conditions, core holdings on an asset allocation basis such as infrastructure should be central in a portfolio.

But investors shouldn’t expect too much too soon. In terms of outlook, 2022 will continue to be bumpy. That means strong discipline in both asset allocation and diversification will be rewarded.

A key feature of this cycle has been its speed: it means you have to stay on track to maximise returns and balance risk.

Will Hamilton is the managing partner of Hamilton Wealth Partners

will.hamilton@hamilton
wealth.com.au