Myles Zyblock, Chief Investment Strategist of Scotia Global Asset Management – which manages over $190 billion for millions of investors in Canada and around the world – shares Scotia GAM’s latest market and investing insights.
This month, Myles discusses the impacts of inflation and central bank actions on global markets and how investors should respond.
We are in an (almost) everything bear market. Price weakness in government bonds, starting in 2021, was joined by most non-U.S. currencies and credit, and then by global equity markets in early 2022. In recent months, many commodity prices joined the list.
Worries about global inflationary trends seem to have set this ball in motion. Unexpectedly strong gains in the prices of everything from food to fuel helped to knock the government bond market off its pedestal. The latest data shows that the global rate of inflation has surpassed 9%, or its highest level, in at least 30 years. The decline in bond prices resulting from the rapid and widespread increase in inflation has since wiped about $13 trillion in market value from global bonds. Perhaps that might have been the end of the story were it not for the central banks.
The inflationary “tsunami” has been a call to action. Central banks began monetary tightening (effectively by raising interest rates) to combat rising inflationary risks, beginning in emerging economies and progressing to developed nations in early 2022. Central banks were left with little choice, given that the inflation rates in almost every one of these nations had been running far above either comfortable or targeted levels.
As the monetary tightening cycle continued, it not only picked up pace but broadened to include unsuspecting economies – like the Eurozone, where the central bank was formerly thought to be preoccupied with structural deflationary risks. Remember, the European Central Bank (ECB) was one of the first major central banks to institute a negative interest rate policy in prior years. Not any longer. The ECB’s target rate sits at +0.75%, and financial markets expect it to rise to 2.5% by the middle of 2023.
Global monetary actions are now being applied with a force that matches nothing seen since the early-1980s. The U.S. Federal Reserve, for example, has lifted its policy rate by 300 basis points since March of this year, the sharpest increase since 1981. Similar stories have been unfolding in Canada, the United Kingdom, New Zealand, Australia and elsewhere.
It has been the pace of tightening that is at the heart of the issue for global financial markets. As central bank interest rate increases accelerated, asset prices, in addition to government bonds, were drawn into the vortex.
After years, even decades, of declining interest rates, the world was positioned to expect more of the same. Households, businesses, and even the government behaved as if this low or even declining interest rate environment would persist. Canadian households offer one example of being caught flat-footed, with debt-to-disposable income rising to an unprecedented 170%.
At this time, it is our view that financial markets – stocks, bonds, and select currencies – are incredibly oversold. It is always difficult to time a bounce, but one seems increasingly likely given that asset prices rarely move in a straight line.
Long-term investment success necessitates the creation of a portfolio that is prepared for a variety of economic and financial market eventualities. Forecasting the future with any useful precision is nearly impossible. Inflation may continue to be elevated for years to come because of the rising costs associated with the onshoring and reshoring of production, prolonged trade conflicts, or geopolitical strife. Or, perhaps, the ceaseless forces of innovation and an ageing demographic re-assert themselves, placing inflation back on a downward path. We simply cannot be certain.
Diversification acknowledges that the future is unknowable, despite that its portfolio benefits are well established. Typically, it is contextualised throughout the stock-bond domain to include geographies, styles, duration, and credit quality. While these are important considerations, a broader perspective is required, which includes real assets, private markets, and other alternative investments. Scotia Global Asset Management has been working hard over the past several years to develop new options across these three additional asset classes for our investors.
Myles Zyblock is a recognized North American strategist, regarded for his investment insights that blend finance and psychology to capture major inflection points in financial markets. Myles has over 25 years of experience in guiding and advising on asset allocation for a diverse set of institutional and retail advisors globally. Myles joined the firm in 2013 as the Chief Investment Strategist, working closely with the Investment Team. His experience spans multiple asset classes and geographic regions.