In reference to the 19th-century fairy tale ‘Goldilocks and the Three Bears’ in which Goldilocks eventually discovers a bowl of porridge which is neither too hot, nor too cold, but is ‘just right’, market participants have coined the term ‘Goldilocks economy’ to refer to a macro-economic climate which similarly is neither too hot, nor cold, but is ‘just right’ for investment returns.
The years leading up to 2020 before the pandemic were, quite accurately, a Goldilocks economy from the perspective of equity investors. Economic growth was positive and stable in the developed world, growth was strong in China and the emerging world, inflation was low and stable, interest rates low and stable. This was an environment that was ‘just right’ for equity markets. Exceptional returns, in fact, were the outcome, year after year, as the not too hot, nor too cold, economic climate persisted.
“For the loser now will be later to win… For the times they are a-changin’.”
Bob Dylan
As is the case with all climates, they change. And the market environment is clearly in a state of change now. Economic growth rates in 2021 and expected for 2022 are much higher, so too is inflation, while interest rates have started to rise as well.
This means that what may have worked in the past decade for investors will not necessarily work in the future. Further, it’s unclear what that future economic climate will be. Will inflation remain above trend, or decline back to pre-pandemic lows? Will interest rates keep rising, or remain subdued?
“Living on a thin line…. Tell me now, what are we supposed to do?”
The Kinks
Markets today are on a thin line between two very different outcomes. On the one side, the powerful factors which gave us the pre-pandemic Goldilocks economy could re-assert themselves, and they certainly are powerful forces. Demographics, high levels of debt, globalisation, and deflationary new technologies all contributed to keeping inflation low and growth positive. These factors have not gone away and so could likely reassert themselves. Such an outcome would likely result in a strong bull market for stocks.
However, it’s also hard to argue with inflation prints of 7% in the US and 5% in Europe, their highest since the author of this newsletter was still in diapers, interest rates are rising too, and market volatility spiking. Add in a growth slowdown, and a bear market could be the outcome.
Gone, we would argue, are the days of relying on passive investment funds (ETFs) to do the hard work for you. Back, we would continue, are the days of stock picking offering a far better outlook for investors. Picking stocks, we conclude, which command pricing power, can continue to grow even through higher inflation and a weaker economy, and which trade on reasonable valuations, offer investors an ‘all-weather’ strategy which should perform well no matter what changes occur in the investing climate… an investment strategy which is ‘just right’.
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