Commodity Watch: Fighting Muscle Memory

<p data-pasted="true">I spent the last three weeks on the road (London, Kuala Lumpur, Singapore, Manila and California) listening to clients, investors and allocators. Some lasting impressions:</p><p style="margin-left: 0" data-pasted="true">We seem to be in investment regime purgatory. At one end is the gravitational pull of US tech companies, AI innovation and the muscle memory of strategies that worked best since the GFC, namely low-cost beta and indexing to a subset of US public equities. At the other end are changing economic conditions. Increasingly and across jurisdictions, a recognition (concern?) is emerging that the past 15 years may not repeat or even rhyme as the assumptions that drove returns become less relevant.</p><p style="margin-left: 0">Inflation is one example. Between 2010 and 2020, 82% of all months had a 2% or lower inflation rate (in contrast only 36% of the months in the 18 years before the GFC had an inflation rate of 2% or less – are we going back?). Post-GFC, central banks effectively distributed free chips and pumped oxygen into the casino. The highest risk assets (venture) won. But changes are afoot. Inflation is now 3.8%. This increases the likelihood of persistent higher interest rates even as the US undergoes a physical asset renaissance that requires more debt. Higher interest rates will impact portfolio returns. Higher P/E ratios and geopolitical volatility only add to changing conditions and could impact portfolio composition.</p><p style="margin-left: 0">Stuck in this “no man’s land” are allocators trying to balance US tech’s potential and past performance (clients’ appetite for US tech is unabated) with uncertainty and increased real world volatility. Outside AI, conviction is less universal and increasingly shaped by local experiences and needs. Reliance on now disrupted LPG and diesel in Asia, for example, is driving the importance of resilient supply chains and physical assets across that region- the US is not there yet.</p><p style="margin-left: 0">Despite the changes, the pull of muscle memory is strong. Many investors remain anchored to a regime defined by low inflation, abundant liquidity, low interest rates, and the steady outperformance of a narrow set of public equities. That instinct was rewarded for so long it is hard to discard. But it is also becoming harder to reconcile with present realities: stickier inflation, higher-for-longer rates, greater uncertainty, geopolitical fragmentation, and the revenge of the physical world: energy, infrastructure and supply chains reasserting their importance.</p><p style="margin-left: 0">Something must change or break. But we still don’t know how it will shake out. Existing portfolio strategies might not be obsolete, but they are incomplete. Investors need to diversify, stay nimble, place greater emphasis on downside protection and focus on strategies that can combat or benefit from a changing environment and that complement, enhance and SHIELD (our previously shared mnemonic: short duration, hard assets, income, enduring demand, appropriate LTV and debt) portfolios. Diversification, income, duration and hard assets might help. As would, a global approach.</p>