Balance sheet strength and pricing power – the ability to pass on price rises despite tough economic conditions, will be vital, and evidence is already beginning to emerge of a period of creative destruction, as zombie companies that benefited from the era of cheap money will fall by the wayside.
In such an uncertain and unusual environment, it is also likely that volatility would remain elevated, which would play into the hands of active managers and hedge fund strategies.
Low inflation and low rates equated to equity markets being narrowly driven for many years, making passive strategies much harder to beat, but what we have seen this year may become more of the norm, with greater dispersion creating opportunities for the best active strategies to outperform. Multi-strategy hedge funds have been one of the few sources of positive returns this year.
Higher allocations to cash may be tempting and could be beneficial, to take advantage of the buying opportunities that a period of stagflation/weakness in markets eventually creates with a long-term perspective.
However, while nominal returns on cash and equivalents are rising and will continue to do so, they are still expected to remain negative in real terms.
But much has already been discounted and we are likely close to peak inflation; the change in direction will be an important shift for markets.
Also, unlike the GFC, this cycle is not driven by the need for financial deleveraging, and balance sheets of households, businesses and banks are generally strong. This will help to minimise the slowdown ahead and gives the scope for economies to bounce back quite quickly.
At the same time, valuation opportunities have opened up for longer-term investors. With careful diversification, and asset allocation designed for the environment ahead rather than that of the past decade, we believe it is important to ride out any short-term volatility and take advantage of setbacks in markets as the cycle evolves.
Andrew Hardy is investment director at Momentum Global Investment Management
