Do it yourself

The global macro landscape remains in flux. A strange mix of structural deflationary forces is colliding with equally powerful inflationary pressures. Technology, demographics, geopolitics, and policy responses are all pulling in different directions — making this one of the most complex investing environments in decades.

I am not competent enough to decode where the current conditions are driving us. Nonetheless, I would like to share some random thoughts with the readers and seek their views on these.

Inflation vs Deflation: The great tug of war

At the structural level, Artificial Intelligence, aging demographics, and the rapid adoption of renewable energy are profoundly deflationary for the global economy.

·         AI is driving efficiency, collapsing cost structures, and displacing traditional labor models.

·         Demographics in most major economies — from China to Europe to Japan — are suppressing consumption growth and wage pressures.

·         Renewables are gradually reducing marginal energy costs.

Yet, short-term inflationary winds continue to blow.

·         Fiscal profligacy, especially in the US and large emerging economies, ensures that governments remain the biggest spenders.

·         Deglobalization and parochial geopolitics — from tariffs to tech embargoes — are reversing decades of supply-chain efficiency.

·         Rising defense spending, both in the West and the East, adds another layer of price rigidity.

Ironically, even AI — while deflationary in the long run — is pushing up energy prices in the short run, as data centers consume unprecedented power.

The result is a macro paradox: consumer inflation may stay moderate, but asset price inflation looks inevitable.

Japanification — slow growth, aging demographics, and low yields — already grips China and the EU. In contrast, the US remains the lone outlier, buoyed by fiscal stimulus and a technology cycle.

Gold: Monetary alchemy or bubble in waiting?

Gold remains the ultimate barometer of trust in fiat systems. As the world lives with near-permanent fiscal deficits, the case for gold as a hedge against monetary debasement remains compelling.

However, a curious distortion has emerged:

The total volume of paper and digital claims on gold — ETFs, futures, tokenized products — now vastly exceeds the quantity of physical gold available. This means that, in the event of a systemic rush for redemption, the notional market could implode under its own leverage.

While dedollarization and rising central bank purchases continue to support the short to mid-term case for physical gold, the near-term structure looks speculative. A bubble in gold positions cannot be ruled out, just because of over-financialization.

Bitcoin: The digital store of value narrative

Bitcoin’s journey from fringe curiosity to mainstream asset continues. Institutional acceptance is growing; sovereigns are experimenting with it as a reserve diversifier. Banks like J. P. Morgan Chase, which termed Bitcoin “fraud’ not long ago, have now embraced it. The key driver remains distrust in fiat money and political money printing.

Yet, the coming wave of official digital currencies (CBDCs) could complicate the landscape.

Governments will likely pitch their CBDCs as “stable digital cash,” competing for legitimacy and mindshare.

If Bitcoin manages to retain its decentralization ethos and scarcity narrative, it could coexist as the digital equivalent of gold — a hedge against monetary mismanagement rather than a transactional currency.​

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Bonds: The calm before a possible storm

Central banks across major economies have begun cutting rates again, signaling confidence that inflation is under control. Markets have bought into this narrative. However, no one seems positioned for a reversal — a renewed spike in inflation due to energy, wages, or geopolitics.

If inflation re-accelerates, the bond market could face a brutal adjustment. Duration-heavy portfolios, built on the assumption of declining yields, remain vulnerable.

The irony is that sovereigns need low yields to fund ever-rising deficits — and this need might override pure inflation management. That tension will define fixed income in the years ahead.​

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Equities: Between resilience and fragility

Global equities are not in bubble territory — though certain US pockets (AI, mega-cap tech) show unmistakable signs of exuberance.

The greater risk lies in a material correction in US markets, which could reverberate globally through portfolio rebalancing and risk aversion.

However, there’s a counterweight: if developed market central banks ease more aggressively than expected, it could unleash a wave of liquidity toward emerging markets. The result might be a sharp rerating of EM equities, particularly those offering growth and currency stability.

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The Big Picture

We are living through a multi-speed world:

·         The US remains inflation-tolerant and growth-driven.

·         China and Europe slide deeper into disinflation and demographic stagnation.

·         Emerging markets stand at the crossroads of opportunity and volatility.

·         Markets are oscillating between the two poles of fear (inflation) and faith (liquidity).

Navigating this phase will demand humility, optionality, and patience — and an acceptance that the next decade will likely reward flexibility over conviction.

 The latest episode of global inflation is impacting peoples’ lives in multiple ways, especially in developed countries where the present generation of citizens has not experienced this kind of rise in the cost of living; borrowing cost and challenges in accessing consumer credit. It is of course a significant challenge for the young investors and professional money managers who have been raised in an environment of profligate fiscal policies; abundance of liquidity; near zero cost of borrowing; persistent struggle to mitigate the deflationary pressures and unchallenged US supremacy over global markets and geopolitics. For them all the assumptions that underlined their investment strategies might be falling apart; just like the Dreamliner Titanic.

This episode of inflation and consequent monetary tightening would indubitably prove to be an important life lesson for the young investors and money managers; and go a long way in defining the future investment strategies and market directions.

Besides, there are some other noticeable side effects of the inflationary pressures on the global socio-economic milieu. For example consider the following:

There are several reports indicating that harassed by the rising cost of living and high rentals, many youngsters may be returning to live with their parents; several more may have delayed the decision to leave the parental homes; yet some other who were living alone are moving in with their partners and friends to save on rental and other costs (for example see here). It may be too early to conclude anything, but if this trend sustains we might find it catalyzing some interesting changes in the demographic profiles of many countries; housing market; immigration policies etc.

There is enough anecdotal evidence available to indicate that employees demand higher wages to manage the rising cost of living; but they seldom agree to wage cuts during the deflationary phase. The businesses therefore usually engage in workforce realignment to optimize their wage bill. The senior employees whose actual contribution is stagnating but wages are rising, are invariably replaced by younger employees which cost much less simply due to their lesser vintage. Inflation thus causes higher unemployment in middle and upper tier employees, who are either forced out of the labor market or accept new jobs at much lower wages. The governments however do not have this luxury of letting senior people go. They usually meet the goal by imposing a moratorium on fresh hiring and rationalizing non-wage costs, e.g., travel.

The products’ prices usually do not move in direct proportion to the raw material prices. During raw material inflation the margins of most companies shrink, unless they enjoy significant demand elasticity for their respective products and are able to pass on the entire raw material inflation on to their customers. However, during the raw material price deflation phase, a majority of companies do not pass on the benefit to their customers. This is the phase when most companies, that have survived the inflationary period, see their margins expanding.

As the rate of inflation declines, the prices of consumer goods do not necessarily fall. They just stop rising at a faster rate. Thus, if the wages of households have not risen in line with the rise in the cost of living, the hit to their consumption and/or savings could become structural.

Financial repression is one of the worst impacts of inflation. The savers lose real income while the borrowers get money at much lower real cost. Post inflation this situation is rarely reversed. Neutral real rate is usually the best case in a deflationary period. Positive real rates are not seen to last for any meaningful period.

To control inflation, a variety of fiscal and monetary policies are used by the governments and central banks. Higher interest rates, lower liquidity, higher tariffs to curb demand, subsidies to the poor to augment their income are some of the popular tools used to mitigate inflation and its impact. However, in case of deflation the use of fiscal policies is not very popular; even though in some cases incentives are offered to encourage demand. Withdrawing fiscal subsidies and incentives in the post inflation period however proves to be a serious political challenge. Thus, while the monetary expansion could be moderated in a relatively shorter span of time, the fiscal corrections could take much longer.

 Inflation has been one of the central themes in global trading strategies in past one decade. During 2010-19, the central banks of developed countries (primarily US Federal Reserve, European Central Bank and Bank of Japan) struggled to build inflationary pressure in their respective economies, to attain a minimum level of inflation they considered necessary to motivate investments and sustainable growth. Incidentally, none of the Central Bank targeting higher inflation has so far been successful in their endeavor. Nonetheless, the sharp rise in global commodity prices in past few months has triggered a rush for “The inflation trade”.

 In Indian context, prices of all key commodities (metals, energy, food, cement, textile, and plastic etc), communication, healthcare and education, etc have seen strong inflation in past 6 months.

In its latest monetary policy statement, RBI admitted that “The outlook for inflation has turned adverse relative to expectations in the last two months”. The RBI expects the inflation to remain above its tolerance range for at least six months more. The policy statement reads, “Cost-push pressures continue to impinge on core inflation, which has remained sticky and could firm up as economic activity normalises and demand picks up. Taking into consideration all these factors, CPI inflation is projected at 6.8 per cent for Q3:2020-21, 5.8 per cent for Q4:2020-21; and 5.2 per cent to 4.6 per cent in H1:2021-22, with risks broadly balanced.”

The commodity sector has been one of the best performing sectors in the Indian stock markets in past 6 weeks. A number of brokerages have upgraded their outlook for steel, cement, gas, and chemical etc producers. Many have argued this to be a sustainable and durable trend and once in a decade opportunity to trade the inflation. For example, the brokerage firm Edelweiss expressed exuberance over steel prices and said, “Going ahead, we expect a blockbuster Q3FY21 with record margins in store. Furthermore, structural shortage of steel implies the rally in ferrous stocks has more legs despite their recent run-up. We remain positive on ferrous”.

I spoke with some steel and cement dealers, in Delhi, UP, MP and Bihar, in past two days. All of them appeared bewildered by the rise in prices. All of them cater to the small private construction segment, and none of them confirmed any sign of demand pick up in that segment. Being in trade for many decades, they were sure that demand is certainly one of the key factors driving the prices of steel and cement higher. They guessed, it could be a mix of supply chain disruptions, import restrictions, large inventory building by China and most importantly, the “understanding” between the domestic producers that could be driving the prices.

On the other side, Chinese Yuan has appreciated dramatically in past couple of months. This CNY appreciation has come along with first contraction in the Chinese consumer price index, since global financial crisis. At this point in time, it is tough to say how much of Chinese deflation is consequence of CNY appreciation, but it must certainly have some role. If the strength in CNY reflects the policy decision of Chinese authorities, we need to worry about deflation which China will be exporting rather than the inflation.

My take on the inflation trade, especially in Indian context, is as follows:

A large part of the global inflation in past 9 months could be the consequence of (i) supply disruption due to logistic constraints; (ii) inventory building by large consumers like China; and (iii) weakness in USD.

After reading and listening to views of various experts, I have concluded that that China might have built large inventories of all essential commodities (especially metals and energy) to hedge against (i) Trump victory and consequently intensifying trade war; (ii) longer lockdown due to pandemic Both these conditions have failed. Regardless of popular opinion, my view is that CNY strength is a Chinese gesture to US for ending trade dispute. If Biden reciprocates well to this gesture, inflation may not be a concern for next 10yrs at least.

I shall therefore avoid “The inflation trade” for now. However, if I see a sustainable pickup in demand next year, I shall be inclined to buy some domestic commodities like cement and chemicals (primarily import substitute).