Last week we discussed the current situation for the global economy. We concluded that we are not seeing enough evidence (yet) to convince us that a recession is imminent, but the risk of recession has risen and should be taken seriously.
How, then, should investors be positioned to navigate 2022-2023 and the elevated risk of recession?
Over the past 30 years investors have gotten used to low inflation. This meant that an easy solution to the prospect of higher market volatility during this period has been to increase cash balances. Cash works well as a risk reduction strategy when faced with higher market risk in a low inflation environment.
But investors old enough to remember the 1970s and 1980s will recall that high inflation meant that, whatever the market risk, cash was not your friend. Inflation eats into the value of cash. A rate of inflation of 9% means that, if you hold cash for 1 year then its real value (after inflation) will decline by 9% by the end of that year.
We know that the current market volatility and macro-economic uncertainty is driven by higher inflation. That means cash is no longer necessarily your friend as an investor in this current market climate.
The answer, in our view, is: ‘resilience’. Resilience is the capacity to recover quickly from difficulties, similar to the ideas of toughness and flexibility. In the context of a portfolio, this means owning assets which can outperform cash during a period of higher inflation, and can continue to deliver solid investment returns even if the market is volatile.
In practice, we believe this means investing in businesses with resilient characteristics, trading at attractive valuations. Understandably, there are not many of these investment opportunities out there. But they are there if investors look hard enough (or if they invest in a fund strategy that does the looking for them).
Businesses growing their revenues due to structural reasons, like for example the adoption of new technologies (artificial intelligence, cloud computing, 5G). Businesses with low exposure to rises in input cost inflation. Businesses with pricing power, who can pass higher inflationary prices on to end users. Businesses with strong balance sheets (i.e., high cash, low debt).
This is where, we firmly believe, investors should be positioned to navigate any period of economic uncertainty we may find ourselves in.
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