Sign up to myFT Daily Digest to be the first to know about Markets news.
The writer is co-founder and co-chairman of Oaktree Capital Management
As an investor who has seen more than a few market cycles, I have learnt to approach macro forecasts with scepticism. Such predictions normally turn out to be either unhelpful consensus expectations or non-consensus forecasts that are rarely right. But as I explain in my latest memo to investors, they should not be dismissed entirely, particularly now.
Why? To invert what Warren Buffett once told me, the macro future may not be knowable, but it certainly is important. Since the tech bubble burst in 2000, the market has appeared to think less about events surrounding individual companies and stocks and more about the economy, monetary and fiscal policy, and world events. That has been even more true since the financial crisis in 2008.
Macro considerations are certainly in the ascendancy, centring on the subject of inflation. Over the past 16 months, the US Federal Reserve, Treasury and Congress have used a firehose of money to support, subsidise and stimulate workers, businesses, the overall economy, capital markets and securities markets. (In fact, I think of 2020 as the year the word “trillions” came into everyday use.) One of the results has been fear of rising inflation.
The debate rages on regarding whether this phenomenon will prove permanent or transitory. There is a great deal riding on the answer, because accelerating price increases would doubtless lead to higher interest rates and thus lower asset values, and also the need to cool off the economy. There are intelligent people on both sides of the argument, but I am convinced there is no such thing as “knowing” what the outcome would be.
Consider the limitations of what the Fed knows. For years, central bankers in the US, Europe and Japan have targeted a healthy 2 per cent rate of inflation, but none has been able to produce it. This despite continuous economic growth, significant budget deficits, rapid expansion of the money supply through quantitative easing and low interest rates — all of which are supposed to be inflationary.
Today, by maintaining its high level of accommodativeness, the Fed demonstrates that it is worried much more about economic sluggishness than it is about inflation. But even if the former is the greater risk — and who’s to disagree with the Fed and insist it is not — the risk of persistently high inflation is still real.
Further, Fed leaders often hold contrasting views about this phenomenon, and some even admit that they are not 100 per cent sure they are right. This is the kind of candid speech we need. But it is clear that we cannot conclude “we have the answer” on the subject of inflation . . . or even that there is “an answer”.
What about markets? What do they know? While markets are usually good “observers”, hyper-attuned to current developments, they can be fickle in terms of their reactions to events. They are also rarely good “predictors” in the sense of knowing what comes next.
Rising inflation and the associated fear of higher interest rates have been used to explain much of what has been happening in the stock market over the past few months.
However, in June, we had bouts of stock market weakness, reportedly on inflation fears, but also rising bond prices (and declining yields), seemingly based on bond buyers’ conviction that economic weakness will keep inflation subdued. And we saw gold, the classic anti-inflation tool, marked down. Markets often behave in ways that make little or no long-term sense.
The truth is that we know very little about inflation, including its causes and cures. I describe it as “mysterious”, so I believe we should put even less stock in predictions surrounding price increases than in other areas.
If we cannot know whether today’s inflation will prove transitory or be with us for a while, is there nothing for investors to do? The answer lies in the title of a memo I wrote in 2001: “You Can’t Predict. You Can Prepare.”
No one can confidently predict whether we are entering an inflationary era, but the consequences of doing so would be substantial. So I consider it reasonable for investors to give a nod to the possibility of higher inflation, but not to significantly invert asset allocations in response to macro expectations that may or may not prove accurate.
We all have views about the future, but as we say at Oaktree: “It’s one thing to have an opinion, but something very different to assume it’s right and bet heavily on it.” We generally do not bet on macro developments.
Unhedged — Markets, finance and strong opinion
Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here to get the newsletter sent straight to your inbox every weekday