Who’s normal is this anyway?
As the world emerges from pandemic, more and more corporations, economists and politicians are trotting out the phrase ‘new normal’ to describe permanent changes to the business and societal norms that were accepted prior to the two-year-long COVID-19 and lockdown interruption. The phrase, they say, describes the accelerated adoption of technology by businesses and consumers, and the emergence of hybrid home-and-office work arrangements, among others. But is this ‘new normal’ useful when offering financial or risk advice to you clients?
Financial decisions informed by context
Context is important for all decision making, but it is this writer’s opinion that financial or risk advisers who simply offer up the ‘new normal’ as a motivator for important insurance or investment decisions will not cut the proverbial mustard. As an aside, the origin of the mustard idiom is unclear, with some sources linking it to agriculture and dating it to the 1600s, and others suggesting it was a butchering of an 1890’s military expression ‘does not cut the muster’. Be that as it may, for those in the advice game it makes more sense to think of the economic and financial environments as ‘normal’ or ‘abnormal’, and to assure their clients that the financial and risk advice offered is appropriate for the prevailing climate.
Thus ends a rather convoluted introduction to a fascinating dialogue held between Peter Kent, Co-head of SA Fixed Income at asset manager, Ninety One, and Sir Bradley Fried, former Chair of the Court of the Bank of England. The conversation sought to explore the global and local economic outlook under the heading ‘A perfect storm’. Sir Fried kicked off by describing the three-decade period spanning the fall of the Berlin Wall in November 1989, to the election of Donald Trump as President in the United States, in November 2016, as an important period in our history, before comparing that period to the craziness of present day. His objective was to determine what mix of global macroeconomic factors constituted normal versus abnormal.
From relative harmony to chaos, virtually
“In those three decades, there was relative harmony between nations; globalisation happened apace, including significant growth of global supply chains; markets opened up across the East and created access to Western markets; and Western markets enjoyed access to Eastern products,” Sir Fried said. This period was punctuated by benign inflation and low interest rates. “In October 2022, the world feels like a very different place: China is sabre rattling over Taiwan; we have the absolutely brutal and unlawful invasion by Russia of the sovereign nation of Ukraine; we have instability in Europe; Brexit afflicting the Eurozone and Britain; a lurching to the right in Italy and Sweden; and an increased polarisation of political views in G7 countries,” he said. And then the punchline.
According to Sir Fried, the relative calm of the three decades starting 1989 should be labelled ‘abnormal’ and the craziness we are navigating today, accepted as ‘normal’. Normal, as it turns out, is defined by the uncertainty caused by clashes across civilizations and business models; conflicts of interest; and disagreement over basic life philosophies, all spiced up with high inflation and interest rates… Sir Fried also made an interesting observation about the shape of the economic recovery following the pandemic, which might explain some of the turmoil we face today. He explained that the recovery was more like the letter ‘K’ with some countries, industries and regions doing really well, sloping upwards on the top end of the letter juxtaposed with groups of people who were left behind economically and educationally, on the bottom leg of the ‘K’. “Some have done really badly and the gaps between winners and losers has been great,” he said.
Finding commonalities between central bankers and gamers
The following paragraphs contain excerpts from the dialogue which may prove useful in navigating financial markets over the next three to five years. We begin with monetary policy, considering the potential for global recession and finally, seek some South Africa specific conclusions. On monetary policy, Sir Fried compared the challenge facing central banks as similar to those faced by modern day computer gamers, who have to keep hundreds of factors in balance to prevail. Central bankers face ongoing tensions between inflation on the one hand, which is pernicious and has to be returned to the central bank’s target level, and the ongoing demand and supply ‘tug of war’ that is often decided based on external factors that are totally out of central banks’ control.
“If you look at a snapshot of the state of the world right now, a lot of the inflation in the G7 countries, and especially in Europe, is linked to energy prices,” Sir Fried said. You would know, dear reader, that gas and oil prices are soaring on the back of the Russia-Ukraine conflict and consequent sanctions; limited supply from OPEC nations; and of course, growing pressure for economies to shift away from fossil fuels to clean energy. A second external macroeconomic factor affecting both developed and emerging market economies is the unprecedented US dollar strength, with the Japanese yen down 25% and the British pound and euro down 20% against that currency year-to-date October 2022. And a third, is the wide range of global supply-side constraints that emerged during pandemic and persist to this day.
Bond investors need controlled inflation
These are factors that asset managers, central banks and even governments can do precious little about. The only option available to you and your clients is, therefore, to take note of this ‘abnormal normal’ and make decisions about your clients’ financial and risk portfolios accordingly. Central banks and governments that are keen to crush rising inflation will have to turn to interest rates, more specifically by hiking them, and / or quantitative tightening. Sir Fried reminded the audience that central banks had a mandate to deal with inflation, with the caveat that the tools available to them to fight it could also push an economy into recession.
Kent welcomed the inflation explainer, saying that those criticising the South African Reserve Bank’s (SARB) recent rate hiking decisions were out of line. “As a bond investor, the only way you get to buy the 30-year SA Government Bond at a reasonable level is to know that the SARB has your back from an inflationary perspective over that period,” he said, adding that if government cannot issue that bond, its infrastructure and social programmes cannot be funded.
At the time of writing, it seemed likely that most of the developed world was either in recession, or headed for one, bringing with it the threat of stagflation. A reminder, courtesy Wikipedia.org, is that ‘stagflation or recession-inflation is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high’. The conversation quickly turned to whether the global economy would have a hard or soft recessionary ‘landing’. Sir Fried observed that the world faced incredibly tough times, but that outcomes were seldom binary. “There is a decreasing level of liquidity globally at the moment which is going to impact vulnerable business models and vulnerable asset classes,” he said. “When you have a crisis an asset class that was hitherto regarded as safe can become regarded as risky”.
Advice for financial intermediaries?
Financial intermediaries were encouraged to take a close interest in their clients’ portfolios. “It is at these moments that arbitrages start to exist, assets become mispriced and there are temporary lulls in liquidity that throw out serious opportunities,” concluded Sir Fired. “Sophisticated, thoughtful fund managers [will respond in such moments to] capture the arbitrage opportunities and manage their clients through the crisis and on to a soft landing”. As for Kent, he suggested that the ‘abnormal normal’ was something that emerging markets have been dealing with forever. “The current inflation [and market] volatility is not new to us,” he said, before commending the SARB for its credible performance through crisis.
Writer’s thoughts:
As global recession looms, local financial services consumers will increasingly turn to their financial intermediaries to navigate them through the economic malaise. Do you believe you are equipped to make the necessary tweaks to your clients’ financial and risk portfolios to navigate high inflation, high interest rates and recession? Or do you rely on the experts at asset managers and investment and insurance product suppliers to get you through? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
