The risk is that while the Fed waits for inflation to average above 2% for an extended period of time, asset prices in other parts of the economy will have gone completely bonkers. That raises the danger of a crash, to add to the risk of inflation destroying portfolios.
If inflation persists it will be bad for stocks as well as bonds, particularly given the extremely expensive valuation from which they start. (Before anyone pipes up about low bond yields, remember they will no longer be low, leaving stocks exposed.) Henry Maxey, investment director of Ruffer, calls this “Jurassic Risk”—a newly mutated dinosaur could be on its way to chomp investors’ portfolios. He adapted the following chart, in which the orange dot shows where we are now, from work by Gerard Minack:
In the long run, the Ruffer argument is that we are facing the death of the 60/40 portfolio. Such a balanced allocation is awful if both stocks and bonds go down. But what else is there? Inflation-protected bonds remain under-appreciated and top the list, followed by equities that can benefit from the conditions ahead. Ruffer has also experimented with cryptocurrencies. Much of the current institutional willingness to examine the crypto world comes from the sense that they will have to try something beyond stocks and bonds.
One final problem for asset managers is, of course, the need to guard against the distinct possibility that somehow the regime change doesn’t happen after all. Unfortunately, it will continue to be necessary to guard against the risk of being wrong. But there’s a strong and reasonable case that a regime change is under way.
Survival Tips
Continuing on the recent theme of music from movies, which has the best soundtrack? I’m not thinking about musicals here, but films with a really interesting collection of sounds playing in the background. My cautious nomination would be the Molly Ringwald teen classic Pretty in Pink (a choice that gives away my age, but such is life). Apart from the title track by the Psychedelic Furs and the OMD classic If You Leave that rolls over the prom at the end, it also includes gems like Left of Center by Suzanne Vega, Shell Shock by New Order and Bring on the Dancing Horses by Echo and the Bunnymen. And Please, Please, Please Let Me Get What I Want by the Smiths, which I linked to not long ago. It all suits me. Any better sound tracks out there?
John Authers is a senior editor for markets. Before Bloomberg, he spent 29 years with the Financial Times, where he was head of the Lex Column and chief markets commentator. He is the author of The Fearful Rise of Markets and other books.