Inflation may be a real threat for Australia and most of the world, as China continues its merry growth path, but this is unlikely to last, the annual van Eyk Research conference was told yesterday.
That’s the good news, according to independent London-based economist Andrew Hunt. The bad news is that the threat of inflation may well be replaced by the threat of deflation by about this time next year.
The conference, which attracted a record 420 planners and managers in Sydney, looked at a range of scenarios for the investment world over the next 12 months. Inflation, and the consequent movement of interest rates and currencies, was a major short-to-medium-term concern professed by several speakers.
But Hunt, who is one of the independent advisers to van Eyk, said he believed the efforts by Chinese authorities to rein in the economy would eventually take hold, possibly resulting in a hard landing for that country.
Likely interest rate rises in the US and Japan, the world’s two largest economies, and reduced import demand by China and other developing countries, could push the world back to a deflationary mode.
“It may be a bit like it has been for Japan,” he said.
Japan had oscillated between inflation and deflation for the past 20 years, with the share market doubling in value in some expansionary years and then halving a couple of years later.
“It’s a very difficult environment for businesses to operate,” he said.
It was only about this time last year, for instance, that the consensus view was that deflation was more of a threat than inflation.
With such volatility, van Eyk cautioned advisers about adopting consensus views in their assessments of markets.
John O’Brien, van Eyk’s head of research, said that “a consensus starts out by being right but ends by being wrong. Reality changes, but the consensus doesn’t change”.
He said he always advised his researchers that while they might have the correct answer about something one day, the world could change such that this was the wrong answer the next.
In van Eyk’s case, the research firm employs the services of non-consensus investment and economics analysts Andrew Hunt Economics and Williams Inference Centre, and consensus and data provider Heuristics.
O’Brien said that investors faced three basic, or cognitive, problems: adopting a model which does not correspond to reality; having to act on partial information; and making adverse investment selections.
It was clear from the global financial crisis that many models did not work during that period. They were based on history and often did not reflect fundamental valuations.
With respect to acting on partial information, he said that investors had to do this every day. And they also made adverse investment selection decisions because they are humans.
As an example, the chief risk officer of a large US structured finance mortgages investor had, for the past 18 years, made an actuarial provision for loan defaults of 8 per cent. But in that particular market, the actual default rate had been almost zero. So, just prior to the sub-prime crisis, the conservative provision was adjusted down.
O’Brien said this showed that, sometimes, even a 20-year track record is not enough on which to make prudent decisions.
