Adviser-to-client template: Have we turned a corner with inflation?

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Dear Client,

As you might have seen, inflation looks to have turned the corner, even though the jobs market remains as strong as any period in history. In fact, inflation seems to be moderating globally, albeit at different speeds in different regions.

They say markets often climb a wall of worry and that has certainly been the case thus far in 2023. Warren Buffett famously described this phenomenon in 2008, saying in the last 100 years we’ve “endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the market rose from 66 to 11,497.”

Turning to more recent events, we’ve seen sentiment change from a state of worry to more neutral expectations. To our eye, risks remain, and important unknowns need to be discounted. That said, we of course welcome the recent downturn in inflation and have great faith in the make-up of your portfolio in working towards your longer-term goals.

Looking ahead, the ability to generate stronger passive income from bonds and cash is the one change over the last 18 months that stands out to us. Cash rates are obviously much better now than at any time in the last decade, but bonds are arguably just as attractive, if not more so, with   government bond yields now closer to 4%. This is a net positive and something we anticipate your portfolio will benefit from.

A crucial question in the conversation around inflation is: What are the investment implications if the next 10 years feature consistently higher or lower inflation and interest rates?

We view this as investors, not economists, and so remain open-minded about the different paths from here. If inflation proves sticky, we hold assets that can do well in this environment. Conversely, if inflation falls quicker than expected and stays there, we have assets that will do well too, such as government bonds and stocks more broadly.

It’s important to remember than not everything in a portfolio is expected to go up at once. If everything is going up, that’s obviously great news, but it can highlight potential problems with the construction of your portfolio. A truly robust portfolio should have offsets against different environments and there should be things that aren’t working as well as things that are.

Yes, cash is attractive, but it has stiff competition. For example, short-term government bonds, which are currently offering similar yields to cash, would benefit from a fall in rates. Unlike cash, they have sensitivity to the economic environment which means if we do experience slowing economic growth, they can support your portfolio when the stock market might fall.

As we always say, ups and downs are part of the investors journey, but we will climb the wall of worry together.

Regards,

Adviser