The world is uncertain but investing is still a good idea

The Middle East, global trade, and the inner workings of Washington or Westminster capture the public imagination. Unfortunately, given the prominence of such news over others, fears over adverse political and geopolitical outcomes also, more often than not, significantly hinder investment appetite.

If the world is “going to hell in a handbasket”, aren’t my investments in danger?

To be sure, we don’t invest to profit from accurate geopolitical predictions. Most people invest to save for retirement, put their kids through education, protect against inflation, pay off debts, buy a house, or pursue other specific life goals.

I have even read a story about someone whose sole financial goal was to outbid a high school rival for their childhood home and rent it back to them at market rate. To achieve all of these, the sole prerequisite is that assets behave in a predictable fashion over the long term, regardless of turbulence.

And, despite narratives to the contrary, this is exactly what they have been doing.

Equity markets are behaving exactly as they should. Equity investors have often been accused of sleepwalking into an AI bubble or a geopolitical trap. Even as Hormuz remains closed for almost four months, equity markets are near all-time highs. Yet, it is not the job of equity investors to bet on geopolitical outcomes. By buying a share in a company, an investor buys a portion of its profits.

In the last quarter, US large-cap profits posted their best quarter in five years, up 28%. AI is, at the very least, promising unprecedented productivity gains, so margins could improve further. Inflation, the key risk, is actually positive for stocks, as it could drive investments away from fixed income. The index being 7% higher than before the Iran war began is not folly. It is the market stating that its core function, assigning a price based on profits, is more important than abstract geopolitical concerns.

Fixed income also behaves as it should. Despite debates over the present levels of debt and sustainability of the debt trajectory, all valid long-term concerns, the latest pressures on the fixed income are the function of one variable: inflation. Inflation is the enemy of fixed income.

Bonds can’t protect investors from inflation levels above their original yields at the time of purchase. If one has bought a 3% bond for 5 years, their biggest concern is >3% average inflation over that period. Bond markets have spent decades in the “Great Moderation”, a regime where globalisation and central banks moderated macroeconomic volatility and kept inflation at bay.

The regime was reinforced after 2008, when central banks sought to reduce overall market risk through asset purchases. After the pandemic and the war in Iran, bond investors, most of whom were not around in the early 1990s, are being re-educated in inflationary outcomes. But it is precisely because their fundamental premise works that yields may again come down, and prices rebound if inflationary pressures recede.

We invest to achieve goals. Our goals can be achieved through investment as long as the basic asset classes, equity and fixed income, perform their function in portfolios, with a modicum of predictability. This crisis should not scare investors away. It should remind them of the inflationary perils of cash, and of how asset classes usually work.

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George Lagarias is Chief Economist at Forvis Mazars.

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