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Articles by Oliver

Oliver Shale

Investment Specialist, US | Ruffer LLC registered representative

13 January 2025

When Star Wars was released in 1977, it was a standalone film. Perhaps, you might say that it was expected to be transitory. Quite quickly, however, its rise proved higher and more durable than expected. In 1981 it was retitled Episode IV: A New Hope, and there were another five subsequent films and three prequels.

Much like the original Star Wars movie, inflation today is expected to be a one-off occurrence. This is despite almost all examples of inflation historically seeing multiple episodes, each wave rising more and subsiding less, in an inflationary process.

Today’s market has A New Hope: that the pain of 2022 is in the rearview mirror and won’t repeat itself. We think there are risks to positioning a portfolio entirely based on this singular outcome. In this article we dissect why we believe inflation, and especially unanticipated inflation, will be one of the most important drivers of asset prices in the coming cycle.

THE DRIVERS OF INFLATION

One parallel we can draw from nearly every inflationary process we study is that they are not linear, but instead occur in waves, with higher highs and higher lows each time.

There are two main reasons for this. Firstly, the conditions that lay the groundwork for inflation don’t fade in just one wave. The deflationary forces of integrated markets, cheap labour, cheap goods, cheap energy and cheap capital, have been disappearing for years. Secondly, the policies and the appetite needed to deal with inflation don’t appear after just one episode. Interest rates must usually be hiked – and stay tight – through some economic and market pain. For this to be palatable, people must hate the pain of inflation more than they hate the pain of dealing with inflation.

There are three important drivers of inflation: inflation expectations, fiscal policy, and the balance of power between companies and workers.

The recency of an inflation experience can be extremely important in ‘priming’ a population to expect a price movement in a particular direction. Anchored inflation expectations work in both directions. Today we have a population that has a recent inflation experience at the forefront of its mind and despite a fall in the inflation rate, consumer prices are still nearly 25% higher than they were pre-covid.

We can usually identify a keen political appetite for governments to spend as well as a procyclical interaction with monetary policy. In the gold standard era, fiscal policy was mostly balanced in peacetime, and it was governed and offset by monetary policy to keep overall price stability. The experience of the 1970s was that loose fiscal and loose monetary policy caused inflation, before Paul Volcker solved it in the 1980s with tight monetary policy. In the 2010s in the West tight fiscal policy dominated the loosest monetary policy ever seen to produce a decade of 1% inflation.

Our view: since the end of the gold standard US governments have been prone to making use of the magic money tree. Loose fiscal and monetary policy in 2020 and 2021 resulted in inflation. Today, the budget deficit as a percentage of GDP remains larger than any outside of a crisis since 1946. Governments will keep spending big until inflation presents a constraint.

The balance of power between capital, workers and taxpayers is a fundamental driver for structural inflation. In the US and the UK, the bargaining power of labor is increasing. Total working days lost to strikes is at one of the highest levels since the late 1980s. Strikes including the Screen Actors Guild, Boeing, United Auto Workers and healthcare workers, among others, have been highly publicized. Many have led to significant pay rises – 8.4% per year for the next four years in the case of Boeing. The inference is clear. Nominal wages have not been keeping up with inflation. Workers are angry about that and feel they have the upper hand in negotiations.

WHERE WE ARE TODAY

Today, we think the foundations for a second wave of inflation are laid. Inflation is not yet at target and unemployment is hardly a problem. Asset prices are at all-time highs. Equity risk premia indicate a level of risk appetite not seen since 2000. Credit spreads are as tight as they have been since the global financial crisis. This is the environment in which the Federal Reserve has elected to cut interest rates (starting with 50bps, no less!), whilst corporate earnings are rising (doing so for the first time since 1986).

We have made the case previously that the Fed is a ‘paper tiger’. It talks like a tough institution, keen to hike. But if presented with any kind of stress in markets or the economy, our view was that it would cut quickly. Inflation was first revealed to be above target in March 2021. It was only 12 months later, with inflation running at 8.5% and unemployment at 3.6%, that they began a hiking cycle. Late to hike and now fast to cut at a time of elevated levels of risk taking.

Asset prices matter because this is the first time where hyperfinancialisation has been so deeply entrenched into the US economy in an inflationary regime. This can prove reflexive. Management teams make recruitment decisions based on their share price, companies pay employees in stock and fund buybacks with debt, consumers take cues from their portfolios going up and spend more money as a result.

Central bankers have a difficult tightrope to walk. If asset markets keep rising, a second wave of inflation, the preconditions of which are already there, is a high likelihood. If asset prices head down and the economy follows, we know from recent evidence that policymakers will push hard against a recession. The Fed – and asset markets – are heavily reliant on inflation staying low and rate cuts coming as a result.

We believe we have left behind the regime of no inflation risk and the emergence of a second wave would have significant implications for portfolios.

THE BEST ASSETS FOR INFLATIONARY TIMES

We think a second wave of inflation is not a risk to dismiss. A quantitative lookback through history can help determine the portfolio implications of such an inflationary regime change.

Our Head of Investment Strategy, Teun Draaisma, studied just this when co-authoring a 2021 paper titled The Best Assets for Inflationary Times. The research looked to accurately define the inflationary regimes that have persisted over the last 100 years of market history and assess their impact on a variety of asset prices.

These regimes capture both the level and direction of inflation, leaving four quadrants to be understood. Importantly here, the ‘inflation’ environment – when inflation is both high and rising – is by far the most difficult for asset allocation. Equities and bonds tend to struggle. Traditional diversifiers such as gold and oil do not have consistent success. A diversified basket of commodities is one of the few strategies that can appropriately protect portfolios.

These times of inflation come with much more volatility in both economic variables and politics, and a less stable environment for taxes and rates makes it harder for businesses to invest. It is no surprise that peaks and troughs in equities closely align to the troughs and peaks in inflation over time. It is a force that matters.

Perhaps most important is the impact it has on stock-bond correlations, which become positive when inflation is high, making bonds no longer effective diversifiers. This can produce the sort of devastating portfolio outcomes we saw in 2022 as inflation risk takes the market by surprise.

Asset markets are unprepared for a return to the inflation quadrant, yet we believe the groundwork has been laid. Fiscal and monetary policy is being eased nearly everywhere, labor market and immigration issues are top of the ballot list, and animal spirits have been unleashed. The damage a second wave would cause, much like we saw in 2022, would be severe. In a world of inflation volatility, a portfolio cannot be invested for just one outcome. Asset allocations must be active, and careful management is needed to protect against the risk of inflation.

Articles by Oliver

Oliver Shale

Investment Specialist, US | Ruffer LLC registered representative

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Piers Wheeler

Director – Institutional

T +44 (0)20 7963 8258

Developing and executing asset management strategy for capital raising and strategic relationship management. Coverage includes EMEA, Asia and Australia. Piers joined Ruffer in 2021, having previously worked with asset management firms including Eastspring, AMP Capital and LEK as a strategic consultant. He holds a MA from the Bayes Business School and a BA (Hons) from the University of Oxford.

Annabel Paterson

Senior Associate – Institutional

T +44 (0)20 7963 8123

Joined Ruffer in 2021, having graduated with a first class honours degree in land economics from the University of Cambridge. After two years working with the UK Private Wealth team and completing her IMC and CFA Level I qualifications, she now supports Ruffer’s global business development and client servicing efforts.

Articles by Annabel

The views expressed in this article are not intended as an offer or solicitation for the purchase or sale of any investment or financial instrument, including interests in any of Ruffer’s funds. The information contained in the article is fact based and does not constitute investment research, investment advice or a personal recommendation, and should not be used as the basis for any investment decision. References to specific securities are included for the purposes of illustration only and should not be construed as a recommendation to buy or sell these securities. This article does not take account of any potential investor’s investment objectives, particular needs or financial situation. This article reflects Ruffer’s opinions at the date of publication only, the opinions are subject to change without notice and Ruffer shall bear no responsibility for the opinions offered. This financial communication is issued by Ruffer LLP which is authorised and regulated by the Financial Conduct Authority in the UK and is registered as an investment adviser with the US Securities and Exchange Commission (SEC). Registration with the SEC does not imply a certain level of skill or training. © Ruffer LLP 2025. Registered in England with partnership No OC305288. 80 Victoria Street, London SW1E 5JL. For US institutional investors: securities offered through Ruffer LLC, Member FINRA. Ruffer LLC is doing business as Ruffer North America LLC in New York. Read the full disclaimer.

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London

Ruffer LLP
80 Victoria Street
London SW1E 5JL

Directions | Map +44 (0)20 7963 8100

Paris

Ruffer S.A.
103 boulevard Haussmann
75008 Paris, France

Directions | Map +33 (0)1 88 45 02 54

New York

Ruffer LLC
300 Park Avenue
New York NY 10022

Directions | Map +1 917 947 3003

Edinburgh

Ruffer LLP
31 Charlotte Square
Edinburgh EH2 4ET

Directions | Map +44 (0)131 202 1602

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