By Jonathan Armitage, Chief Investment Officer MLC Asset Management
This content is produced by The Australian Financial Review in commercial partnership with MLC.
For investors the past 18 months have been quite the rollercoaster ride. The pandemic coupled with the reaction from governments around the world has largely torn up much of the economic and political orthodoxy that has been prevalent in developed economies for some time.
As Nobel Prize-winning economist Paul Krugman once remarked, governments and central banks have made a “credible commitment to irresponsibility” as they have endeavoured to stave off recession with massive doses of fiscal and monetary stimulus over the past 18 months.
If we look back at history during times of significant disruptions what we tend to see is the acceleration of existing trends. With COVID-19 the most obvious example of this acceleration is how we live and work and how this has supercharged the transition to new forms of technology.
For markets, the impact of this faster technology evolution, coupled with stimulus, has translated into extraordinary returns for investors. But as we see newer strains of COVID take hold around the world it is unlikely those returns will be repeated in the next 12 months. As the rollercoaster continues, we are seeing no shortage of uncertainty out there - both economically and within capital markets.
However, for Australian superannuation investors it should not just be the next 12 months that is in focus, but rather the next three to five years. This is why bigger questions such as the outlook for inflation are important.
Just over a year ago talking about the possibility of increasing inflation would have been a fringe idea - it was a word that many people would have thought had almost been removed from investing dictionaries. However, as economies rebounded more strongly than anticipated, inflationary pressures have built up driven by a multitude of factors including labour shortages and supply chain disruptions. This is coupled with higher energy prices and the impact of increased rents in major cities as economic activity recovers. When it comes to inflation, the big question for investors is whether these elements could be more permanent than markets are currently discounting.
Another factor adding to potential inflationary pressure is a general air of uncertainty around what the future holds as we move to a post-pandemic world. The reason being is some of the COVID-related issues affecting markets are proving to be more resilient than people had predicted even three or four months ago.
For example, COVID restrictions continue to slow down port movements so global shipping is moving more slowly impacting supply chain at a time when demand is rising. At one of the world’s largest shipping terminals in China boats are taking double the normal amount of time to load and unload. While in the United Kingdom, there is a shortage of qualified truck drivers leading to delays in food and supplies getting to end markets.
Individually, these issues may not cause concern but added together they demonstrate that business operations globally are facing more challenges than before COVID and that the cost of doing business has risen. Companies will look to pass those costs on to consumers, driving prices higher for different goods and services.
Interestingly, another inflation risk is the changing nature of globalisation as the economies of developing nations mature and they start to see upward pressure on wages. The upshot is global manufacturing costs which have been depressed for close to three decades will begin to rise.
As we navigate this ever-changing economic environment, with many possible twists and turns still yet to come it’s important to remind ourselves that humans are quite poor at predicting the future. Examples from the past five years prove this. Few people predicted a global pandemic, nor did many predict Brexit and no doubt people underestimated the potential for Trump to become US President back in 2016.
Acknowledging this inability to predict every outcome is important if we are going to produce the best possible returns over the medium to long term for Australian’s who are heading towards retirement. Navigating the ebbs and flows of markets is also about considering what may happen rather than what we want to happen. That is why MLC uses a scenarios process – the Investment Futures Framework – to examine a variety of different economic and market outcomes. This framework allows us to be responsive and strike the right balance of Participate and Protect. Participating in investment opportunities to maximise returns, while dynamically using protective strategies to provide a cushion during downturns.
While considering what might happen plays a role in investment decisions the ability to focus on the data and insights that matter by blocking out the noise is just as important.
Too often investors focus on the short-term such as a payroll number in the United States, geopolitical to-ing and fro-ing, the headline inflation number or the Reserve Bank’s interest rate decisions, but what superannuation investors need to focus on is the longer-term. Sure, some of these events may play out over a longer period but a well-constructed portfolio will take into account a number of different outcomes and this is important in an environment where the rollercoaster ride looks set to continue.