An old married couple have just moved into their dream home.
They are surrounded by half their life savings in the form of new furniture and decor. As the husband puts his feet up in front of the fireplace, his wife suggests they talk about buying home insurance, you know, just in case of flooding or a fire.
He replies, 'Nah, the chances of a flood or, indeed, a fire burning down this house are so slim, it’s not really worth considering.'
On a scale of one to 10, how loudly would you scream at this couple to act on the possibility of a fire anyway; not because the chances of it happening are slim, but because, if it did happen, the impact would be cataclysmic?
Where markets are concerned, uncontrolled inflation is as close to a house fire as you can get. Left to rage, the impact could be devastating for economies, markets and portfolios that are not appropriately prepared. Like the couple in our story, it would be reckless for investors not to think about how their portfolios will fare if the worst were to happen.
Inflation remains the single biggest investment risk on the horizon. On this point, it seems most market participants agree. Similarly – along with industry and central banks – they are largely united in the view that present inflation is transitory and will likely remain under control.
On the whole, we share this view. But inflation has, in the developed world, been so well constrained for close to 40 years that the market has been quick to shrug off the possibility – slim as it may be – that all of us could be wrong. It is this complacency that concerns us.
There is no crystal ball, and history has a way of telling us what we want to hear. After all, there is a history to support every possible point of view.
Parallels can be drawn between where we are today and the Great Inflation of the 1960s and 70s, when policymakers put rapid inflation down to transitory factors – droughts, oil prices and union activity – and were ultimately proved wrong.
When inflation woke from its decade-and-a half-long sleep in the spring of 2020, there was the widespread presumption that it would fade away by the summer.
Now, on the cusp of another winter of rising prices, even the chair of the US Federal Reserve admits that “we have to be humble about what we know about this economy”.
While we may be able to make educated guesses about the impact of current inflation on wages, economies, and demand, we are less certain about its impact on the most unpredictable of variables – human emotion. Enter, the turbo-charger effect.
Let us return to the couple in our story above and imagine they also own a jam shop. As they sit in front of their new fireplace watching the 10 o’clock news, they see a story about inflation rising to 10 per cent.
