In the heyday of the baby boomers’ asset accumulation phase, they significantly benefitted from the two most important performance enhancing “peptides” at the time. Inflation and compounding were formidable catalysts on the velocity of dollar-value growth in an investment portfolio comprising high allocations of property and cash. Equity and purchasing power were being amassed at record pace.
The 1970s through to the mid-1990s were the golden years for strong capital gains as property prices experienced outsized annual growth and interest rates above 10 per cent doubled accumulated savings in less than seven years. But both economic drivers were demonised as detracting from long-term sustainable growth and policy makers set about cutting both. Inflation and compounding were marginalised in a way similar to the “less salt is better” campaign.
Today, benign inflation and historically low interests rates have stripped these two powerful forces from the equation and left us with a profitless economic period of consistent activity without capital growth.
For a decade or more, Japan, the US and Europe have had insufficient inflation to underpin a required velocity of wealth accumulation. They move from crisis to crisis and struggle with economies grasping for sustainable equity growth across all mainstream asset classes.
Cheap money is not the answer to generate sustained levels of profitable and worthwhile economic activity. If completed investments do not return viable levels of return on investment in accordance with the business case, then equity owners or creditors are quickly looking for the exit.
A good dose of inflation
What the world needs is a good dose of inflation to undo the damage being caused by low global bond rates. When central banks move beyond the nationalisation phase of defibrillating global balance sheets, we will hopefully return to a more normal level of inflation and interest rates that will validate the important interconnectedness of inflation and compounding to a strong economy.
Unintended consequences need respect, careful observation and ongoing management. We know what the excessive use of antibiotics can do to a balanced immune system within the body and how it has the potential to weaken overall resistance levels. Excessive sanitisation can also greatly reduce natural fight-back systems. Beating down inflation and orchestrating lower interest rates to create a healthy economy is having the opposite effect right across the world and spawning a variety of unintended side effects.
Return for risk needs to be factored back into the investment equation. Yield curves need to return to being steep and not anemically flat to inverted. The reward for risk must be tangible. Inflation needs a higher target than during the past 20 years.
Financial planners have a key responsibility to advise clients to adopt a responsible portfolio asset allocation that will balance market volatilities and acceptable returns. The risk appetite decision for 2014 to 2016 will need to consider the possibility of inflation and compounding making a resurgence as this is what normal levels of economic activity and the next boom will undoubtedly resurrect. When you least expect it!
Peter Sheahan is director of interest rate markets at Curve Securities