Liz Truss remains steadfast in her aim of boosting economic growth, and if she gets her way, investors may need to pivot away from the areas that have done well in 2022 so far, according to experts.
The prime minister has had a tumultuous term so far, and was forced to sack former chancellor Kwasi Kwarteng after a disastrous mini-Budget that tanked the pound.
Jeremy Hunt’s first act as chancellor was to reverse the majority of Kwarteng’s unfunded tax cuts. These had been intended to stimulate growth, but were announced at a time when the Bank of England was trying to do the opposite, raising interest rates in an attempt to stifle demand and bring inflation back under control.
Although the reversal of Kwarteng’s policies means the government and the Bank of England are no longer pulling in different directions, there is no guarantee that the Bank will be successful in bringing down inflation and it is not outside the realms of possibility that the government, unwilling to wait, forges ahead again with its growth plans.
As part of a series from Trustnet, we are looking at what assets to hold and avoid in each of four outcomes based on the current aims of the government and the Bank of England: the Bank wins and inflation falls, but at the cost of growth; the government wins, with growth higher, but inflation is still out of control; a ‘doomsday’ scenario of higher inflation and weak growth; and finally the ‘goldilocks’ option, with inflation down and growth on the rise.
The most likely scenario now is that growth remains weak, while inflation is eventually brought under control. Yet it is important to be prepared for every eventuality, which is why a number of analysts below run through what to expect in an environment of high economic growth and inflation.
When it comes to equities, Alena Kosava, head of investment research at AJ Bell, said short-duration assets (such as cyclical value stocks) should do best.
James Sullivan (pictured), head of partnerships at Tyndall Investment Management, agreed with Kosava to some extent, highlighting more cyclical equities such as financials and energy. However, he said these could also be paired with long-duration assets such as technology.
“The pattern is cyclical and/or secular growth styles are favoured over those of a lower beta, more defensive nature such as utilities and healthcare,” the manager explained.
While profitable tech companies may do well in a period of strong growth and high inflation, Artemis’s chief investment officer Paras Anand said it would be a different story for fledging firms in this sector, especially those that have yet to float on public markets.
“Over the course of the past six to nine months, there have been some material revaluations of publicly listed securities, because you've got that daily discovery process and those sentiment concerns are reflected immediately,” he said.
“These revaluations come through with a greater lag in private markets. Meanwhile, a rising cost of capital in inflationary environments puts increased pressure on those investments to prove their economic return sooner rather than later. So we see the greater risk is in private markets.”
Everyone agreed that long-dated government bonds would underperform in this environment, as central banks would raise interest rates faster.
Baylee Wakefield (pictured), multi-asset fund manager at Aviva, noted: “As we have seen this year, high inflation leads to underperformance of government bonds. Inflation means that the spending power of the coupon reduces, which affects its value. New bonds issued then pay more as central banks increase interest rates.”
As a result, Kosava said shorter-dated bonds would be a better bet, while Sullivan recommended corporate bonds instead.
Another area of interest is alternatives, with Kosava saying a high inflation/growth environment would prove to be supportive of commodities, infrastructure and property assets.
Wakefield agreed with her, saying: “When economic growth and inflation both rise, particularly from a demand-pull perspective, real estate often outperforms. This environment leads to higher corporate profits and income growth, meaning that tenants can afford to pay higher rents. Valuations also increase as replacement costs increase.”
However, she warned cost-push inflation can lead on to slower economic growth, which reduces occupier demand.
Vince Childers, head of real assets multi-strategy at Cohen & Steers, said that infrastructure’s lower volatility and more defensive characteristics mean it would lag other core real assets as growth surprises to the upside, although he would still anticipate positive absolute returns.
Overall, he said it would be commodities that would lead the way, “both commodity futures as well as the producers of commodities, the natural resource equities”.