Old Robbie Burns was on to something when he wrote:
“In proving foresight may be vain:
The best laid schemes o’ Mice an’ Men Gang aft agley
An’ lea’e us nought but grief an’ pain”

It is certainly true that in our field of work, our best laid plans can be pushed badly off course by the unexpected events that exercised Robbie, but then as that other great thinker, Inspector Clouseau, put it “we should expect the unexpected” and frame our decision-making accordingly.

We, as most others, did not expect the Covid pandemic, the Ukraine war or indeed, the ineluctably tragic events in the Middle-East this week which have roiled energy markets and impacted financial markets everywhere.

There are currents that ebb and flow around financial markets, some of which are random and unexpected, and others which have longer and deeper structural implications. The first cannot be hedged in any significant way. The second category is more amenable to pre-planning and forethought.

This is why investors who have short time horizons should restrict themselves to short horizon investments. This is also why it is so important that we have a full picture of your financial situation so that we can put the right asset in the right box, over the right time horizon. Happily, in this respect financial markets have recently opened up with short-dated risk-free assets offering high gross equivalent returns for the first time in a decade.

In the longer run it is important to have some kind of mental model of what you think the drivers of the economy are and thus, financial markets might be. Probably the key input into a long-term investment strategy is the cost of capital. It is this aspect of finance that is causing a great deal of anguish in markets today.

Businesses, investors, consumers, home buyers, and traders have been used to dealing in a market characterised by “free money.”

Since the turn of the century and the nadir of the dotcom bubble, the pricking of the subprime bubble, and Euro crisis of 2010 onwards, the cost and supply of credit has never been cheaper or more abundant. As you will know, this period is now over and there is considerable angst in markets surrounding the rise in inflation and the linked rise in bond yields. Put simply, the cost of capital, that key input, is going up.

Importantly, as this process plays out, the consequences of free capital will emerge, and they may not always be pretty. However, in our view, once the initial change (paradigm shift) has occurred, and it is highly likely we are nearer the end than the beginning, a higher cost of capital will be beneficial to investors since capital allocation decisions will, necessarily, become more rigorous.

Our mental map of the world runs as follows:

The long period of zero interest rates was a necessary bridge to support weak demand in a period when global goods prices were deflating due to excess supply, principally from China. Once that bridge was crossed, and it has been for a variety of reasons (China-US confrontation and war amongst them), interest rates would rise. Note that this rise would only take interest rates back to “normal.” Every homebuyer in the UK should know that the “normal” base rate of interest is nearer to 5% than 1%.

Inflation would rise as a result, but higher inflation would be tolerated to recover “nominal” output lost during the pandemic and preceding financial crises. We do not think that that central banks will wish to tighten policy so far as to induce recession. It is, however, likely that interest rates will stay higher for longer than most people under the age of 40 have experienced.

The US, though expensive, retains an unassailable lead in technology and innovation. The US also retains global confidence as the world’s central bank. This last assumption is likely to hold although it is currently being tested by the antics on Capitol Hill.

Capital is likely to flow to the faster growing economies of the East, albeit increasingly bypassing China. India, Indonesia, and the other large ASEAN economies are likely beneficiaries of Western companies diversifying their supply-chains away from the Middle-kingdom.

We also anticipate accelerated investment in climate friendly infrastructure and an accelerated exit from a fossil fuel economy. $100 oil prices will lead to this transition speeding up as substitution effects take hold more quickly.

When the patrician grandee Harold MacMillan was asked what he feared most in politics, he is said to have replied, “Events, dear boy, events.” Well, recent “events” have contrived to blow these long-term trends somewhat off course, but we believe that they are sufficiently entrenched to support a credible framework for investing.