Off to the polls
This year, half the world’s population will also elect new governments.
Depending on the outcome of the elections in the US, we could see considerable tax cuts and new protectionist measures.
This would represent a major setback for the global fight against inflation.
Additionally, we need to start being honest about the fact that western countries are dealing with serious labour supply problems, which will be a structural driver for inflation for many years to come.
This is being driven by the impact of ageing populations across many European countries.
Germany, for example, is currently losing around 500,000 workers a year due to its falling birth rate and the number of people turning 65.
To put it in perspective, this is more than 1 per cent of the 46mn Germans who are currently in employment, while the current German unemployment rate is only 5.8 per cent.
In other words, Germany will run out of workers over the next years to come.
Unsurprisingly, we have seen the number of strike days in Germany increase by nearly 50 per cent over the past 10 to 15 years, which means wage inflation is likely to be sticky despite a sluggish economy.
As well as the obvious impact on labour supply, this inverted population pyramid is also placing huge pressure on healthcare systems, which is also highly inflationary.
Another new normal
So, how should advisers navigate this new normal, including not being caught out by structurally more volatility in base rates?
First and crucially, with significant rate cuts priced in at this stage in the cycle, they need to hedge against rate cuts not coming through at the same pace and quantity as expected to ensure clients are not caught on the back-foot should rates stay higher for longer.
In this uncertain world, floating rate, senior secured credit offers attractive opportunities for investors.
The floating rate nature provides downside protection if inflation is stickier than expected, while the senior secured nature provides downside protection in case default rates were to pick up as a result of a weaker-than-expected economy.
All in, yields on leveraged loans are still in the top quartile if we look at it over a 20-year horizon.
The combination of higher base rates and attractive spreads over base rates means investors can get high income with downside protection. This also means credit looks cheap versus the stretched earnings multiples on equities.
One of the reasons credit is a relatively safe bet in periods of volatility is that, unlike equities, it does not need much global growth.
This is evidenced by the relatively low default rates for large corporates we have seen over the past few years, despite the recent turbulence.
