Liz Truss’s aim upon becoming prime minister was to stimulate economic growth. While it now looks more likely we will enter a recession in the short term as the Bank of England raises interest rates, who knows what the medium-to-long-term environment will look like?
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.
Alena Kosava (pictured), head of investment research at AJ Bell, said the latter environment is probably the least likely on the balance of probabilities, as central banks are “myopically focused on taming inflation, having been behind the curve and losing credibility”. However, she said it is possible that any fall in headline readings would ease some of the pressure on central banks and may slow the pace of the rate-hiking cycle.
“With that, parts of the market which were hammered most, including growth stocks and long-duration assets, will likely recoup some of the underperformance,” Kosava added.
Tom Kynge, deputy fund manager and portfolio analyst at Sarasin & Partners, said this type of environment would hark back to the “post-2008 investment playbook” supporting fast-growing companies such as technology firms.
“More speculative investments would come back into fashion as borrowing costs fall and funding appetite increases – think small caps and cryptocurrencies,” he said.
“Valuations across asset markets would rise. Assets that provide shelter in rocky markets may perform less well. Healthcare companies prove less attractive when technology companies can fund their growth prospects at low rates.”
James Sullivan, head of partnerships at Tyndall Investment Management, agreed with him.
“This time, it would be high-beta, momentum stocks that tend to outperform, paired with a bias towards cyclically sensitive mid caps that benefit from a fall in input prices,” he added.
“So, one is looking at consumer discretionary, tech and communication services as sector styles, while shunning inflation beneficiaries such as financials and energy.”
In an article published on Trustnet yesterday, Vince Childers (pictured), head of real assets multi-strategy at Cohen & Steers, said that commodities would “lead the way” in a period of rising inflation and economic growth.
But in a scenario in which the economy grows while inflation falls, he said that while natural resources equities would deliver above-average returns, commodity futures would underperform.
Another area that would be likely to underperform is cash.
“Falling inflation leads to lower interest rates, which means that cash savings earn little return,” said Baylee Wakefield, multi-asset fund manager at Aviva. “As economic growth rises, the opportunity costs of holding cash increase.”
Paras Anand, chief investment officer at Artemis, said this related to a risk that investors may be overlooking in the current environment: opportunity risk. With all the focus on the downside, many investors may be taking an excessively defensive stance at the very point when potential returns are at their highest.
“For there to be further downside on the equity or the high yield markets, you'd have to see a type of economic downturn that would fall under the banner of ‘crisis’, where you have a high level of defaults or you have a more significant negative impact on corporate earnings growth, principally from the demand side of the equation,” he explained.
“Therefore, given that a slowdown/meaningful recession is already priced into a lot of public market securities, you could say that a lot of broad asset classes are offering interesting value at the moment.”