Investors should prepare for a period in which long-term interest rates rise and equities de-rate, creating an “unusually sure platform” for losing money, not making it.
This is according to Jonathan Ruffer, chairman of Ruffer LLP. To illustrate where we are in the market today, the investment veteran recalled how Ruffer LLP came into existence after a “correct macro call” in 1994.
“I saw the early 1990s as a bookend,” he said. “Most investors assumed inflation was a modern malaise, with us forever – and yet the three prongs of the trident which delivered inflation had, to my eye, already been blunted.
“Those concerned about the first prong – inflation as the child of too much money in circulation – needed to consider the actions of the Neptune-like figure of Paul Volcker, chair of the US Federal Reserve from 1979 to 1987.”
Volcker is famed for helping defeat double-digit inflation in 1980 by raising interest rates to an “eye-wateringly high” level of 20 per cent.
“The second prong came in the form of wage increases worldwide,” Ruffer continued. “Here, those concerned needed to consider the defanging of the trade unions.
“Divided, the workforce of the early 1990s would resume its role as price-taker, rather than inflation-maker. Wage growth looked to be a past problem, not a future one.”
The third prong Ruffer recalled was the supply chain. At the time, China was emerging as an economic power that had “outgrown its role of making plastic presents for Christmas,” Ruffer said. “Supply shortages looked to be on the way out; supply gluts on the way in.”
He said that these three prongs proved to be decisive in helping Ruffer’s portfolios, dominated by long bonds and paired with equities, re-rate upwards.
“This created an unusually sure platform for making money. And this style of investment, often described as 60/40, has since become enormously popular,” Ruffer said.
“Skip forward 30 years and we are now approaching the other end of the bookshelf: the trends will reverse as we reach a new bookend.
“The primary move from here will be for long-term interest rates to go up, and for equities to de-rate. This creates an unusually sure platform not for making money but for losing it.”
Ruffer argued the scale of money creation, the state of the labour market and the cracks in the supply chain all point to a return in inflation.
“Inflation might remain as a chronic growl, or it might burst into disruptive life,” he added. “Either way, there will be a massive change in asset leadership, with the leaderboard of the past decade to be turned on its head.”
While the unprecedented scale of monetary and fiscal support after the coronavirus pandemic has been well-documented, the state of the labour market is not as clear.
Ruffer argued that the pressure on wages is “in exactly the wrong place for price stability”.
“In Britain, for example, it is highest in the National Health Service (who have kept us well) and the hospitality sector (which will, we hope, keep us happy).”
When it comes to the supply chain, Ruffer pointed to shipping freight prices, which have increased fivefold since the start of the pandemic.
In addition to the surprisingly fast rise of US furniture and television prices, he also pointed to the rapid rise in commodity values.
Performance of S&P GSCI since height of pandemic
Source: FE Analytics
Ruffer said: “If commodities are the inanimate voice of the many, they are shouting the message of ‘inflation onwards and upwards’.
“The increasingly cold war with China means the security of supply is becoming a consideration as important as price,” he added. “Rebuilding lost capabilities at (or closer to) home will come with a higher price tag than importing from overseas.”
Another factor that Ruffer advised investors to consider is the “possibility that money has been irretrievably debased”.
“In 1880s France, paper money was trusted more than the solid silver coins, because the paper was backed by gold, and people trusted gold more than silver,” he said.
“But there comes a moment when people stop trusting a government’s paper – usually long after the evidence the paper is untrustworthy has started to germinate.
“The nations of the British Empire continued to hold their balances in the Bank of England on the basis that Queen Victoria had been a good egg; there is a similar danger that confidence in the muscle of Uncle Sam keeps one in the dollar beyond its worth.”
Ruffer warned that if confidence is lost in the major currencies, “no others are safe”.
He said the drop in GDP through the pandemic, and the sharp rise in borrowing that followed shortly after, “has taken debt-to-GDP levels into unprecedented territory”.
“But it is not precedent which determines the tipping point on confidence,” he said. “It is something much more random, something whose inconsequence nevertheless becomes the moment when the Bastille is stormed.”
LF Ruffer Total Return – a £4bn multi-asset fund overseen by FE Alpha Managers David Ballance and Steve Russell – is up by 31.7 per cent over the past five years, compared with a rise of 30.32 per cent for its average IA Mixed Investment 20-60% Shares peer.
Performance of fund vs sector over five years
Source: FE Analytics
It has an ongoing charges figure (OCF) of 1.22 per cent.