Stock markets are back on the front foot. China and the US this week found a face-saving off-ramp to avert, at least temporarily, a damaging trade war. And with that, as often happens, Mr Market provided investors with a second bite of the cherry. If, earlier in the year, you disregarded the opportunity to reset your portfolio for a changing world, you now have another chance to do so. Take it.
It’s always easier to re-order your asset allocation from a position of strength. Selling at a loss is difficult because we are hard wired to deny the fact that our investments are no longer worth what we paid for them. Having recouped 2025’s losses, you are probably sitting on gains again. Cashing them in for something that now looks better will feel painless.
You may be tempted to put off this reassessment. Relief is a powerful emotion, and getting your head back above water might feel like job done. It is actually only half complete. The growth and inflation challenges that ‘liberation day’ focused our attention on have been parked not resolved, notwithstanding this week’s lower US price growth. The rush back into risk assets and out of safe havens looks like wishful thinking. There is more economic uncertainty than there was six weeks ago, not less. The past week’s trade deals are temporary and non-binding. Tariffs are significantly higher than they were. The market’s exuberance, to borrow a phrase, looks irrational.
The best template that I can see for where investors find themselves today is the late 1960s. The parallel is not exact, of course, but there are echoes. Then, as now, we had enjoyed a long bull market. Then, as now, we faced a nascent stagflation problem. Then, as now, governments were spending too much – guns and butter, they called it.
The decade that followed was not easy for investors. The S&P 500 fell almost 40% between 1973 and 1974. While they bounced back in nominal terms, measured on an inflation-adjusted basis, even including dividends, big US stocks lost 1.4% a year through a decade of sluggish growth and persistent inflation. Profits grew 9% a year through the 1970s, but investors, fearing that the economic malaise would continue indefinitely, halved the multiple they were prepared to pay for a share of those earnings.
Cash and bonds also performed poorly in real terms as central banks belatedly tried to slam the lid on inflation. Treasury bills and government bonds delivered -1% and -1.8% respectively over the decade. The investments that did buck the trend were few and far between but the returns they offered were in some cases spectacular. Gold, oil and wheat performed strongly. The precious metal rose seven-fold – and that was after inflation. The S&P Goldman Sachs commodity index, which tracks a basket of natural resources, turned £100 into £700 even as the S&P 500 index went sideways.
The world is different in many ways from 50 years ago. The global economy is less energy intensive, which is why Russia’s invasion of Ukraine had a smaller impact than the Yom Kippur oil embargo. Today’s less unionised labour market is less susceptible to a wage-price spiral. And today’s central banks are less complacent. The Fed was overly focused on its growth mandate in the 1970s and took its eye off inflation. Today, the reverse is true.
So, I don’t expect an exact re-run of the 1970s but, for a number of reasons, I do expect inflation to be higher and growth lower than the markets are assuming. When I caught up with former colleague Paul Gooden, who runs the Ninety-One Global Natural Resources Fund, he pointed to three drivers of structurally higher inflation.
First, deglobalisation, fuelled by US-led tariffs, and the onshoring that it will encourage. The same theme is evident in higher defence spending in a more fragmented and uncertain world. Second, electrification. This may be the route to a decarbonised world. But in the short term it will demand considerable green capital expenditure. Third, debt and demographics. High debts make inflation an attractive option, perhaps the only viable one, for cash-strapped governments. And ageing populations imply a shrinking labour pool, with improved leverage in wage negotiations. I would add one more to Paul’s list – Victorian infrastructure on both sides of the Atlantic cannot be patched up piecemeal for ever. Replacing our failing roads, bridges, power and water networks will be expensive.
Natural resources performed well in the 1970s. But even in a less obviously inflationary environment hard assets have a place in a diversified portfolio. Ninety One’s analysis suggests that when inflation is higher than 3.3%, natural resource equities average an annualised return of 22%, gold 16% and infrastructure 11%. Global equities manage 9% in this environment and real estate 7%. Bonds delivered nothing at all when inflation was this high over the past 20 or so years.
As well as the structural growth drivers and the inflation protection, natural resources offer a couple of other advantages. Firstly, they are good diversifiers for portfolios that are still over-indexed to the growth investment style and in particular the technology, financials, healthcare and industrials sectors. Energy, mining and agriculture march to a different beat. Secondly, they offer attractive value. Relative to the MSCI All Country World Index, natural resources stocks have halved in value since the financial crisis. They are currently bouncing off a line of support that on a couple of occasions in the past 10 years has been a good entry point.
Investing in natural resources themselves is not straightforward and anyway the equities of the companies that grow them and dig them out of the ground tend to outperform the commodities over time. They are a play on the sustainable transition, an inflation hedge and they are generating cash today and not just promising it tomorrow. In a small way, I am going to add some to the mix.
This article originally appeared in The Telegraph.
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