The inflation pessimists were right. It now looks like UK CPI inflation will exceed 8 per cent soon – although it should fall thereafter because if we are handing all our money over to utility companies nobody else will be able to raise prices.
But what use was this correct call?
In some respects it did make money. Inflation pessimists would have correctly bought gold (which is up 13 per cent on a year ago) and avoided conventional gilts, which have lost 10 per cent since the summer.
But many of us who weren’t expecting 8 per cent inflation also held some gold, simply because it’s sometimes a good portfolio diversifier. Equally, many of us avoided gilts on the grounds that their worst-case losses were worse than those on cash.
In other respects, though, inflation pessimism would not have served us so well. Anyone who had bought Bitcoin in the belief that it would protect them from falls in the value of “fiat money” is now sitting on a 26 per cent loss in the last 12 months, albeit a profit since the summer. And while anyone who had bought index-linked gilts is sitting on a small profit over 12 months, they have lost money since the summer. In both assets you needed more than a correct call on inflation to make a profit.
And then there are equities. The All-Share index is 6 per cent up on a year ago, but flat since the summer and down since the winter. The remarkable thing about this is how utterly unremarkable it is. Looking at a chart of the index over recent months, you would never guess that inflation is at a 30-year high. You could easily have called the market right but got inflation wrong, or vice versa.
Nor would a correct view on inflation have guaranteed a successful stock-picking strategy. If you had looked for companies with pricing power you’d have got into, say, Diageo (DGE) and done OK – but, depending when you bought, you would have probably lost on Unilever (ULVR) and Reckitt Benckiser (RKT). And whilst you would have probably made money betting on larger commodity stocks such as Shell (SHEL) or Rio Tinto (RIO) you would have lost horribly on many smaller ones – as you would if you’d bet on an inflationary boom and bought cyclicals such as housebuilders.
My point here is not to denigrate those who (unlike me) foresaw a big rise in inflation. It’s more significant than that. There’s a big gap between macroeconomic forecasting and investment strategy. Getting macro calls right is not sufficient to get investment strategy right. And sometimes it’s not necessary either (which is just as well). This is not simply because you need to get market timing right – though you do. It’s because the links between macroeconomic variables and asset returns are complex and not always predictable.
This does not, of course, mean economists are useless. It is economists who have discovered useful investment facts, such as the importance of stop-loss rules; the power of momentum investing; the need to be sceptical of active management; and to be on guard against the countless errors of judgment to which investors are prone.
Macroeconomic forecasting however is little use even on the rare occasions it is right. So why do economists do it? It’s because they are paid to. Which itself vindicates economics: people respond to incentives, sometimes in ways that are not socially useful.
