Forecasts generally are reflecting two opposing opinions, says chief investment strategist, but understanding portfolio risk is crucial
Inflation is arguably the most talked about subject in the market right now. But one chief investment strategist has warned investors that, when it comes to inflation, a powerful-sounding narrative is not a reliable gateway to understanding the future.
Myles Zyblock, of 1832 Asset Management, said it’s important people recognize the complexity of the forecasts and the fact nobody, not even the deep research departments of every major central bank, has been able to consistently predict what’s going to happen.
Zyblock’s own reading has led him to conclude that inflation outlooks essentially boil down to two admittedly oversimplified opinions. One, that inflation will become an uncomfortable problem into the future. Those in this camp cite supply-side shortages, runaway commodity prices, and extreme policy stimulus as supportive factors. And two, that inflation is not a major long-term problem. This view points to high total debt levels, ageing demographics in large sections of the world, and disruptive/innovative technology as helpful features.
Zyblock believes both arguments have inherent problems. He said: “The inflationists suffer, in part, from a bout of ‘monetarism’, which has miserably failed the test of reality over at least the past 25 years. And, price has often led to increased supply – an analogy is the ‘hog cycle’ ... think oil in 2008.
“The disinflationists might have Japan as a living example on their side but fail to convincingly show how these factors statistically link to measured inflation. They tell good stories and the data has been on their side for decades, but they have never convinced me that this is how CPI works in the real world.”
Inflation dynamics are incredibly complex and depend on innumerable domestic and global factors. Zyblock admitted that even after studying it for the past 27 years, he doesn’t fully get a lot of what goes into the CPI.
He added: “Economists still actively debate why inflation has trended lower over the past 30 years. They debate why inflation didn’t ‘take off’ in the 2003-08 period. And this is with the benefit of hindsight. So I wonder how they will figure out what inflation is likely to do from here."
Given the complexity and potential for confusion, what’s the conclusion? Zyblock is on the fence and believes both scenarios are possible over the next one to two years. Knowing one’s portfolio exposure to inflation risk might be the most important attribute to understand, he stressed.
He also highlighted the bond market as ample proof of why the subject is so tricky to forecast. The rule that you generally make the biggest returns when, one, there are ample believers and, two, those believers are wrong should put inflationists on alert.
“I am not saying the inflationists are wrong, only that they could be,” Zyblock said. “The bond market has been fighting against this consensus view for a few months. That 125+ basis point rise in the 10-year yield maybe says that the long-dated/high quality bond tantrum might already have happened. To be clear, I am not long-term bullish on bonds. It’s very difficult to be excited about bonds with yields below inflation, never mind the fact that they are miles below inflation plus real growth. It seems to almost 'guarantee' challenging long-term future returns.”
However, he admitted he is less bearish on high-quality bonds than the consensus. Unsure of your position? You’re likely not alone. “I am not sure whether I’ve helped or added to the confusion,” Zyblock admitted, “but I do think it reflects the complexity of the subject, something that should not be dismissed the next time a compelling story about inflation or disinflation crosses your in-box.”
