Investors who buy the dip could find themselves unable to escape from the ravages of an inflation-induced bear market, according to Jonathan Ruffer.
The founder and chairman of Ruffer LLP likened ‘buying the dip’ in today’s markets to swimming at the point where two oceans meet: things can look calm on the surface but below “powerful currents” make for “treacherous conditions”.
“Forty years of a bull market, where for decades ‘buying the dip’ has been a sure-fire idea, is clashing against circumstances and events which may break this benign and predictable investment pattern,” he warned.
“Investors who buy on the dip fancy themselves brave. There’s a self-serving adage for this activity – ‘buy to the sound of gunfire and sell to the sound of the violin’. There should be a footnote: ‘…but not if the prices ruling at the time of the dip are humming to the bow of Yehudi Menuhin’.”
One of these circumstances that is unfolding ‘under the surface’ that Ruffer referred to was the end of freely-moving globalised trade, which he views as inflationary.
“The high watermark of world trade peaked before the Covid pandemic; to repeat, I see the war in Ukraine acting as an accelerant, including in patterns of trade,” he said.
Russia’s invasion of Ukraine has already caused a spike in crucial commodity prices such as oil, wheat and nickel.
Another inflationary development he pointed to is the shift in the axis of economic power from the ‘haves’ to the ‘have-littles’.
“The change in political climate everywhere will encourage financial headwinds in the form of higher taxation and financial repression,” he said.
“The result? Net interest will lag the value of money. And attempts to invest one’s way out of this impasse could easily lead to capital losses – in nominal and real terms.”
Ruffer said that these were the same circumstances of the 1970s – a period of stagflation (high inflation and high unemployment).
UK inflation during the 1970s
Source: Bank of England
Before founding Ruffer LLP and serving as chief investment officer of Rathbones, Ruffer recalled an experience while working at Dunbar Fund managers in the 1970s where one of his colleagues lost his temper with a client who pointed out her real loss compared with inflation.
“The client was told she was seeking after a ridiculous aspiration,” Ruffer said. “Clients, then, appeared to be defenceless from inflation; today the escape routes from it are closing.”
He pointed to the rapidly rising wages at the bottom end of the employment chain as one indicator of more inflation.
“In Britain, the hospitality and service industry are facing a step change in wages; lorry drivers remain in short supply despite de facto wage rises, anecdotally put at 40%,” he said.
“Expect a similar dynamic to the 1970s, when the top earners suffered high tax, falling markets, and yields on assets far below the inflation rate, while the unionised workforce – enjoying beer and sandwiches in 10 Downing Street – were faring well (provided they were in employment).”
Ruffer also noted how during 1972 – when share indices momentarily peaked – there was a similar mood amongst investors as today.
“Then, the mark of successful risk-taking was how much more you could make than everyone else. In retrospect, it was a time to pivot towards keeping safe,” he said.
“It was another 10 years before the market started its next long ascent – but by then many investors had left the markets. The same thing will happen again.
“It might well be hard to deliver real growth in portfolios from here, and it is no comfort if the reason is a pendulum swinging away from prosperity. Confronted by losses, and the prospect of uncertain future losses, many people will, as last time, give up on risk-taking.”
Amidst this backdrop, he said Ruffer’s positioning in long duration UK inflation-linked bonds was a “core element” across his firms’ portfolios.
Indeed, index-linked gilts make up 27% of the firm’s flagship closed-ended £806m Ruffer Investment Company and 24% of its flagship open-ended £3.6bn LF Ruffer Total Return fund.
Ruffer said: “We can be pretty sure that if we have two back-to-back years of high inflation, the market will do what it always does, and extrapolate that figure through to the long-duration end of the bond market.
“If – and it’s a medium-sized if – the world’s way of reconciling high debt with sluggish growth is by allowing inflation, then inflation could easily reach the double digits – in the UK in 1976 it got to 26%.”
This is where the value of his UK 2068 index-linked bonds will be much higher if consensus long-term inflation reaches 10%, he argued.
“This value rises stupendously from there with every tick up in the inflation rate,” he added. “This optionality is for free.”