by Michael Avery
The first half and, in particular, the second quarter of 2022 will go down in the history books as the defining point of economic regime change.
Blackrock believes that we are entering a regime shift from the era of the great moderation, which started around 1985 and ended last year, characterised by steady growth and moderate inflation, to the currently emerging era of increased volatility and rising risk premia.
Key features of the great moderation era were steadily expanding production capacity and demand shocks. Blackrock posits that central banks could easily nudge spending by cutting or hiking rates. But now that has been flipped on its head, largely, Blackrock asserts, due to production constraints triggered partially by the pandemic and, in large part, by the global transition to net zero.
This presents a Gordian knot for monetary policy. A pile-up of global debt to buffer the COVID shock limits the wiggle room of central banks – and makes it more tempting to live with inflation. And the politicisation of everything means policy debates are oversimplified when nuanced solutions are needed. Blackrock believes that all this makes trade-offs between growth and inflation harder and leads to worse outcomes.
PE funds will need to manage proactively to anticipate change and get ahead of it. That will be critical in weathering this period of turbulence and taking full advantage of the recovery to come.
Globally, the data points to dealmakers relying heavily on expanding valuation multiples to support returns over the past two decades, but that won't work in a period of inflation. Locally though, few fund managers have delivered first quartile performance on the back of nuts-and-bolts value creation and a clear understanding of how to manage effectively during a period of rising prices, which we are not unfamiliar with. This should stand South African GPs in good stead.
Yet, I’m not so sure that I agree with Blackrock’s reading of the economic tea leaves.
I see signs all over the place that inflation is already starting to roll over. Weekly wages in the US, adjusted for inflation, are falling off a cliff. This will hit demand harder than any interest rate hikes. And commodities have come back from their recent peaks from base metals to softs. Just watch Dr Copper.
Yet global central banks, led by the Fed, seem determined to assert some control after losing the transitory narrative.
But it’s the risk of being tripped up by the time-lags, which was something that Milton Friedman warned central banks many years ago to watch out for and avoid if possible, that has me most worried.
Leading your economy into a recession when inflation has already turned is an avoidable risk.
Locally, when SARB Governor Lesetja Kanyago, refers to facing a combination of ‘growth risks on the downside and inflation risks on the upside’, monetary policy navigation becomes particularly tricky.
The immediate repercussions of economic downturn, higher inflation and rates (cost of capital) emerging in PE will choke the deal pipeline in the short term, but, as history has proven, will undoubtedly provide fertile opportunity in the aftermath for GPs with ample dry powder.