Adviser-to-client template: Inflation update
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I thought it was important to provide an update as we seem to have turned a corner with inflation.
As you might have seen, the latest inflation number was promising and meaningfully better than expected. Inflation is coming down, with the job market broadly holding up. This is true locally and globally, even if we’re seeing different speeds of change.
They say markets often climb a wall of worry and that has certainly been the case in 2023 so far.
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.”
Since then, we’ve had many more political headwinds, COVID-19, and another war. The market is now up another three-fold. Long-term investing works.
Turning back to recent events, we’ve seen sentiment change from a state of worry to a more neutral position. To our eye, the high-pressure system is still with us, but we obviously welcome the recent downturn in inflation and have great faith in the long-run capability of your portfolio.
Looking ahead, the one enduring change that stands out to us is the better ability to generate passive income. Cash rates are obviously much better now than at any time in the last decade, but bonds are arguably just as good, if not better, with the ability to lock in yields well above 5% for many years. 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, so remain open-minded about the different paths that might happen from here. If inflation proves sticky, we have assets that can do well, including exposure to value stocks. If inflation falls back to target 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. We do not have to look very far to find alternatives to cash that hold up to better scrutiny. For example, short-term government bonds, which are currently offering similar yields to cash, would benefit from a fall in rates and, unlike cash, they have ‘duration’ which gives us a better ability to lock in higher yields for an extended period of time.
We welcome any dialogue on the long-term potential of the assets we hold, so please reach out if you’d benefit from a conversation. In the meantime, we continue to watch developments with interest and will keep you updated if anything requires your attention.
As we always say, ups and downs are part of the investors journey, but we will climb the wall of worry together.
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