Many economists are expecting a return to normal inflation rates, but the FE fundinfo Alpha Manager says all evidence points to the contrary.
He pointed out that consensus forecasts have often disappointed – it was only two years ago that economists were describing inflation as ‘transitory’, but the opposite is true today.
“We’re not economists, but that almost feels like an advantage at this point because they certainly haven’t been covering themselves in any glory – first trying to stoke inflation, then thinking it's not coming, then freaking out about it and now seemingly calling the all clear,” Cutler said.
“We make a layer cake of inflation drivers and 2% is nominal inflation to have a normal economy. Then we look at what else is going on and it all looks very inflationary.”
The main economic drivers we have in today’s economy are very different from the ones that led in the previous decade where 2% inflation was normal.
For most of that time, the global economy had an “amazing economic tailwind” from outsourcing to China, but nearshoring could unwind all of that and add between 0.25% to 1% of inflation a year, according to Cutler.
Likewise, tense geopolitics has also led to massive increases in defence spending, which deliver no benefit to the economy.
“Defence spending is by definition non-productive,” Cutler said. “If you build a tank it doesn't make anything, it destroys things. A soldier or a pilot doesn’t make anything, they just sit there and wait for something to happen.”
Nevertheless, economists continue to ignore these issues and lure investors into a false hope that inflation will return to historic levels, which doesn’t seem viable currently.
“The only thing central banks can really control is people's expectations,” Cutler explained. “If they can convince you and I that we’ll have 2% inflation going forward, then we'll behave like that.
“If we start behaving like we’re going to have higher inflation then they've lost it, because what do you do if you think something is going to be more expensive? You're going to buy now, which pulls demand forward even further.”
By telling investors to expect a return to normal over the horizon, central banks have avoided panic, but they would be allocating a lot differently if they took a more realistic view.
“It just blows me away because people want to believe it so badly,” Cutler said. “That’s the biggest asset that central banks have – people's willingness to believe in 2%.
“But that doesn't mean you should be setting up your retirement portfolio on that. What if it isn't? How are you set up for that? If you're just sitting there with American growth stocks and the dollar, you're not set up very well.”
Cutler said that in reality, economies that have become accustomed to low rates such as the US and UK will struggle in this new environment markets are heading towards.
“Those levels would be good years in places like South Africa, but our whole western economy got addicted to 2%, so going to 4% will be a massive shock,” he added.
“It's been so long since the global financial crisis, which was 14 years ago now. That is almost a working lifespan for an investment manager or an executive of a company, so we’ve had a generation of leaders where all they've known is this nice tailwind to everything. We're stuck on that.”
Despite these warnings, most investors are still following the status quo and allocating to mega-cap technology stocks in the US, which are most vulnerable to high inflation.
Indeed, Cutler said the majority of investors are taking notice of the wrong signals, hence why stock prices in the US have “gone bonkers” on excitement around the “magic productivity unicorn” that is artificial intelligence (AI).
He added: “People have all this cash and wonder where it’s all got to go. They say, ‘well Microsoft released Chat GPT – it’s not growing any faster than it was last year, but okay let’s buy it’.
“There's too much money so it flies under those names looking for a safe place and that's what we're protecting against.”