Pre-empting a return to inflation could prove a costly error

These meetings are a core part of my work as an adviser, but more importantly they provide an opportunity to gauge sentiment and therefore offer up some clues as to how best to anticipate the coming months.

Perhaps the biggest topic that I was keen to explore in these meetings was inflation, and to what extent it is likely to influence investments over the coming period. There is consistent and persistent talk of inflation being ready to explode, and consequently a need to be fully invested in equities to ensure a real rate of return is achieved.

Apparently fixed interest has had its day and we all need to buy the market. In simple terms, this was the basis for much of the discussions. I think it is therefore very valid to report that such a view is not shared by most of the managers I met. If anything, the belief is that we are effectively in deflation in the West until we are not.

There are very sound reasons for believing this to be true, and positioning a portfolio to pre-empt inflation can be very expensive.

To expand on this point is important. Energy costs, food prices and taxes are all rising, hence the regular reports that inflation is apparently rising. But at the same time, unemployment is rising and the housing market is at best fragile.

The biggest single driver of inflation is wage demand, and when budget cuts are the order of the day, there is precious little room for that dynamic to infiltrate the system. Add to this the growing reality that costs to individuals are set to rise while wages remain static and it is logical to conclude that spending amongst consumers will fall. The dramatic fall this week in the share price of clothes retailer Next outlines this very point.

An ironic point in all this is that in the East and Latin America they definitely have inflation worries, but also possess the ability to control it. In the West, with the exception of Germany, we would love inflation to rise as a means of containing our colossal debt mountain, but to date we have very little.

This situation, of course, leads to volatility in markets and hence opportunities for astute investors. However, any returns are still likely to be binary and hence the risk being taken needs to be fully considered.

In summary, we are enduring what can be described as a "risk on, risk off" period in markets. On single days, "risk on" defensive equities, gold and the dollar fall, while on "risk off" days the exact opposite happens . We have experienced both this week.

Such a scenario is likely to persist for quite some time, in my opinion, and as always I believe the primary responsibility for financial advisers lies in not losing clients' capital.This is not always easy, and requires a degree of ongoing diligence. There are no quick fixes and even the heavily promoted absolute return strategies should be viewed with at least a degree of caution.

With some honourable exceptions, many have failed to deliver much in terms of decent growth in recent times. Diversification in terms of holding and asset class is a must, as is an acceptance that single digit real returns are well worth having.

• Ken Taylor is director of Mackenzie Taylor Wealth Management