5 minute read
Don’t fight the principles
One thing is for certain, we cannot forecast the future. Time and time again investors have fallen flat on their faces, because they thought they had the future all figured out and that the opportunity was a sure thing. There is no point in relearning this lesson of history. However, does that mean we need to turn a blind eye to the signs we observe? No. Mark Twain reminded us that “history doesn’t repeat itself, but it often rhymes.” What that might suggest is that certain principles seem to repeat themselves, not in exactly the same format or magnitude, but with similar cause and effect. If we for example observe that the world has a lot of debt, inflation is stubbornly high and certain assets are expensive compared to history, we need to ask ourselves: “Have we been here before, and if we have, what happened next?”
The principles of cause and effect through history will remind you that if debt is too high, the odds are that it will be very difficult to manage stubbornly high inflation, as governments will find it difficult to afford higher interest rates, nor risk sending the economy into a recession through self-intended fast interest rate increases. Some options would include either to cut spending, grow GDP faster, increase taxes or to apply them in some combination. High debt would mean that it would be difficult to use more stimulus to grow the economy. The wrong spending cuts or tax increases can have unintended consequences causing the economy to grow slower, which could exacerbate the debt problem.
High inflation occurs when the costs of goods and services go up too quickly and in effect erodes the purchasing power of your money faster than usual. Cause and effect teaches us that traditionally inflation is controlled by increasing interest rates, but if you do it too quickly or if the magnitude is too high, you could cause a recession, which will also worsen the debt problem. The effect to you as an investor would be that your investments could grow below inflation, which would mean that you would compound backwards. Furthermore, owning growth assets that seem to be trading on valuation levels that are above normal is risky, as the cash flows that are too far into the future lose their value when interest rates rise in an attempt to curb inflation. If the economy slows down or any other unforeseen circumstance leads to the growth of these assets not coming to fruition, the price of these assets will fall, leading to a loss on your investment.
The sensible strategy could be to recognise these cause-andeffect lessons from history and to realise that what worked in the recent past (during a period of controlled inflation, low interest rates and controllable debt) won’t necessarily work now and that you need to diversify your portfolio to make provision for higher inflation or potentially slower economic growth (also known as stagflation). In other words, include assets in your portfolio that through history proved to do well during periods of higher inflation and lower growth. Having a cash-concentrated portfolio is very risky in an environment where stagflation is a serious threat. As Namibians, we can use a ballpark 6% long-term average inflation rate, which would mean that after 12 years, your purchasing power could potentially have halved in value. There is a risk that in the short to medium term, inflation will be higher than normal and therefore higher than this 6% long-term average.
Certain assets have the ability to push through the effect of higher inflation to their customers through price increases, or to partially push cost increases back to their suppliers. This usually happens when they have some form of sustainable competitive advantage. Commodities have also assisted as a hedge against inflation and having the right mix ofcommodities, including gold, can also assist your portfolio. Remember to understand your goals and to try and separate them as much as possible as different goals have different time horizons attached to them. Time horizons determine the magnitude of volatility (how much your capital could fluctuate) that the specific goal can tolerate. In other words, the correct mix of assets to protect against inflation could be completely wrong if your volatility profile is incorrect. For example, if you want to purchase your dream house two months from now, inflation might be one of your last concerns.
In conclusion, remember that you cannot forecast the future (a principle), but don’t fight other principles from history (using an adequate time period) and therefore ensure that your portfolio can tolerate different scenarios (a principle), not just the recent past. Lastly, remember that your wealth management consists of different goals and that you might need to consider a proper wealth management plan (a principle).
René Olivier – Managing Director: IJG Wealth
IJG believes in tailoring their services to a client’s personal and business needs. For more information, visit www.ijg.net.
