In the ongoing regime shift, investors have to deal with significant legacies stemming from the previous ‘Volckerian’ regime, namely two forms of inflation: asset price inflation over the course of three decades and, more recently, inflation in the price of goods and services. Underinvestment in the old economy fuelled, albeit with a lag, the return of good old inflation, while overinvestment in some areas of the socalled ‘new’ economy (the internet bubble in 1999, the tech hype between 2015 and 2021) financially inflated certain sectors.
These sharp discrepancies resulted from a combination of the demand for high returns on equity, which deterred real investment in most sectors, and the low cost of capital, which generated various forms of hubris, bubbles and leverage. Overinvested sectors in the ‘new economy’ may be a rising component of the landscape which lies ahead, yet some of these ‘tech dreams’ may be built on fragile ground. The fate of the broad economy lies, and will continue to lie, in the so-called ‘old economy’, as many people are beginning to understand the impact of scarcity in simple, immediate and vital things. The most obvious consequence is less growth and more inflation at trend: stagflation is the primary risk embedded in the new regime, just like deflation characterised the previous one.
In this new regime, something has got to give and it will, with profound consequences for investors. First among these is the realisation that the returns on equity (RoE) inherited from the previous regime are unsustainable. Investors must also bear in mind that it is highly uncertain whether inflated nominal economic variables will ‘bail out’ the current high asset prices. There will, however, be greater international diversification benefits to be reaped from the slowing global synchronisation of macroeconomic and monetary policy cycles. In general, investors should favour value stocks and sectors that are perhaps less glamorous but have more sustainable business models. Tensions are also likely to emerge in the forex space, wherein it will take some time for a new set of equilibria between major currencies to emerge.