Events in Ukraine are to be seen, first, through the lens of humanity. Through the lens of finance, Russia’s invasion is having the same effect as Covid-19: it is accelerating trends which are already in place. And those trends are inflationary.
Everybody has a view on the war, and I don’t claim extra-sensory insight, but it seems clear that the West has been galvanised out of its lethargy into a visceral rejection of the Russian impulse. Western society is now turning the cancel culture on those whose robust realpolitik includes a colonial approach to other nations. Russia’s strength is military, not economic. But real power lies with economic strength and only in commodities does Russia hold strategic power. This creates an inflationary dynamic. The really notable development is that the German political classes can no longer hold their noses and continue to accept Russian gas – popular outrage forbids it. Wherever one looks, the popular outrage at Russia is forcing disengagement with that empire – much more comprehensively than by formal sanction.
This dynamic will spread to China. Popular opinion in Britain demands that statues of yesteryear be removed – how long will it be before the plight of the Uyghurs today puts a searchlight on those who have prospered from Chinese state beneficence? At a narrow level, China may now be less likely to play the Kyiv card on Taiwan; it is now more likely that there will be a de facto boycott of trade alliances which have grown up – as marriages of convenience – between the West and China. The high watermark of world trade peaked before the Covid-19 pandemic; to repeat, I see the war in Ukraine acting as an accelerant, including in patterns of trade.
There is another trend which has accelerated as a result of Russia’s invasion. The evisceration of Russia is the story of extreme pressure on a cadre of individuals – oligarchs, for the want of an English word – whose money and assets are being put into purdah. The yachts are like Archdukes in 1917: easily spotted, and efficiently despatched. The shadier assets in the leafy streets of London are camouflaged in ownership – and the professional classes who painted the zigzags on the title deeds are themselves coming into scrutiny. Russian involvement will continue to wreak localised havoc in unlikely places – like a rising sea level, you spot the submersion of the low-lying places first, but then mysterious inland lakes appear, seemingly randomly, which are no less connected to that primary dynamic. The Russians have been attracted to London because the robust legal system in the UK, married to practitioners prepared to give it expression, provided a cordon sanitaire around their assets.
This is the latest development in a shift in the axis of economic power from the haves to the have-littles. Extreme wealth is never attractive, especially when its sources are made manifest. The change in political climate everywhere will encourage financial headwinds in the form of higher taxation and financial repression. The result? Net interest will lag the value of money. And attempts to invest one’s way out of this impasse could easily lead to capital losses – in nominal and real terms.
This is what it was like back in the 1970s. I remember a colleague in the fund management company Dunbar Group, where I worked at the time, losing his temper with a client who pointed out that she had suffered a real loss when compared with inflation. The client was told she was seeking after a ridiculous aspiration. Clients, then, appeared to be defenceless from inflation; today the escape routes from it are closing.
Wages at the bottom end of the employment chain are going up very quickly. In Britain, the hospitality and service industry are facing a step change in wages; lorry drivers remain in short supply despite de facto wage rises, anecdotally put at 40%. Expect a similar dynamic to the 1970s, when the top earners suffered high tax, falling markets, and yields on assets far below the inflation rate, while the unionised workforce – enjoying beer and sandwiches in 10 Downing Street – were faring well (provided they were in employment).
Leaving aside these bigger trends, what of the past quarter? It’s been an awkward one for investors, with markets biased downwards, but with several cross currents which were both difficult to navigate, and to balance off against one another. It’s pleasing to report that Ruffer portfolios have had a good start to the year, but that to me is considerably less interesting than the stability of the portfolios’ performance during a quarter when every asset class has been pirouetting.
I remember being told in South Africa how dangerous it is to go swimming at the point where two oceans meet – things can look calm on the surface while, below the waves, powerful currents struggle to prevail, making for treacherous conditions. Forty years of a bull market, where for decades ‘buying the dip’ has been a sure-fire idea, is clashing against circumstances and events which may break this benign and predictable investment pattern.
Investors who buy on the dip fancy themselves brave. There’s a self-serving adage for this activity – ‘buy to the sound of gunfire, and sell to the sound of the violin’. There should be a footnote: ‘…but not if the prices ruling at the time of the dip are humming to the bow of Yehudi Menuhin’. It is too early to say that markets are entering their first bear market for twenty years, and it is fifty-six years since a long-lasting and downward re-rating of markets began in 1966. That downward re-rating came to an end on the day I got engaged, 10 August, 1982 – I thought I’d turned the market, of course, but it turned out to be interest rates which did it.
I continue to think that the core element in the portfolios are the UK inflation-linked bonds of long duration. My technical description of the outlook for the pricing of these bonds, I’m told by a colleague, is like listening to someone explain how to reverse a large van towing a wobbly trailer backwards around a steep corner and into a driveway at the top of a hill – far too many twists and turns to make sense of what’s going on. So let’s try this instead… We can be pretty sure that if we have two back-to-back years of high inflation, the market will do what it always does, and extrapolate that figure through to the long-duration end of the bond market. If – and it’s a medium-sized if – the world’s way of reconciling high debt with sluggish growth is by allowing inflation, then inflation could easily reach the double digits – in Britain in 1976 it got to 26% . The value of, say, our holdings in the UK 2068 index-linked stock is much higher than now if consensus long-term inflation is 10% – and this value rises stupendously from there with every tick up in the inflation rate. This optionality is for free. The optionality is not created by professors of economics doing the sums, or chancellors making speeches, but by investors taking a view, as they have recently done on Netflix and Meta Platforms (formerly Facebook) – down 38% and 34% respectively during the first quarter of the year .
If this review makes for depressing reading, then so be it. For Ruffer, it is simply the backcloth against which we have to invest. Emperors can declare themselves fully-clothed – we accept the trappings presented to us.
When I began in the investment world – at an intermediate share index peak in September 1972 – there was a similar mood to today. Then, the mark of successful risk-taking was how much more you could make than everyone else. In retrospect, it was a time to pivot towards keeping safe. It was another ten years before the market started its next long ascent – but by then many investors had left the markets. The same thing will happen again. It might well be hard to deliver real growth in portfolios from here, and it is no comfort if the reason is a pendulum swinging away from prosperity. Confronted by losses, and the prospect of uncertain future losses, many people will, as last time, give up on risk-taking. Our philosophy is that never is it more important to take risks – but they will continue to be risks to preserve the real value of wealth – and, who knows? – to do somewhat better than preservation.
 Bank of England
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