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Achieving optimal asset allocation in volatile times

Achieving optimal asset allocation in volatile times

A lot of financial market watchers, both professionals and amateurs, are having a devil of a time trying to figure out where markets are heading.

Governments are going all out – the latest EU agreement on a common recovery package being a highly significant example.

Central banks are providing extraordinary backstops.

At the same time, the pandemic-induced shock wave has created tremendous economic uncertainty.

So how exactly can equity investors make head or tail of all this? What asset allocation will best serve their interests now that stock markets are recovering, but in a climate of overall uncertainty? 

A convenient, and frankly lazy way out is to use never-ending “central-bank intervention” as an excuse for whatever your approach may be.

The unknown unknowns

The fact of the matter is that no one – including central bankers – really knows all the consequences of endlessly expanding the money supply to pay for oversized fiscal deficits, not to mention how it will play out in the long term.

It’s worth recalling that when central banks made their first foray into large-scale financial asset purchases in 2009, the vast majority of economists warned that such unconventional monetary policies would drive inflation through the roof.

They did no such thing. On the contrary, interest rates began a decade of dizzying decline. So even back then, nobody had a serious grip (to put mildly) on the economic processes and market shifts set in motion by those policies.

Now fast forward to ten years later and add the threat of a mysterious worldwide virus into the equation. Plainly what’s called for is humility in the face of the unknown and a willingness to refrain from sweeping forecasts – almost invariable built on sand. 

Fortunately, there is an iron law that should enable investors to deal with such extreme uncertainty: not all financial assets are fragile.

In fact, some of them can not only withstand uncertainty (or even chaos) but may even thrive on it.

Essayist Nassim Taleb has referred to them as “antifragile” assets. That’s the place to be, instead of trying to predict the unpredictable. The challenge is determining which assets fit the bill.

Monetary policy impact

In current circumstances, tech companies and gold can be considered antifragile, which explains their high share prices today. 

To understand why, we need to go back ten years.

What the record shows since 2009 is that financial asset prices are the only area in which monetary expansion has produced inflation.

And it isn’t hard to see why. All the vast resources created by monetary policy, which were supposed to inflate consumer prices, didn’t carry much weight in the end against the powerful deflationary forces at work.

Excessive debt loads have stifled demand; globalisation has fueled price competition; population ageing has led to higher savings rates; and new technology has paid off in the form of rising productivity.