Please find below our Investment Market Update as at 17th June 2022. Today’s communication is written by Andrew Dunn (Gus) as Gary is on holiday.
The song remains the same
We have consistently written about inflation this year and it remains the only game in town.
To start, just a quick reminder of what it is and why we are suffering – energy price shocks precipitated by the Ukraine crisis, unresolved supply chain issues and (depending on who you believe) the amount of money that Governments have created during the pandemic. A little inflation is a good thing, hence why most governments target a level around 2%, as it shows the economy is growing, reduces the real cost of debt repayment (think of a fixed mortgage and you getting a pay rise meaning the mortgage is a lower percentage of your income) and it allows for ‘normal’ stable economic policies.
We all personally know the downside of inflation, especially for those on fixed incomes or without earning power. More widely, it can make an economy uncompetitive, discourage long-term investing and where real income growth is negative, reduce demand. So much for economic theory but, right now, the issue is what is to be done about inflation and it is that which is the proverbial Sword of Damocles.
In order to bring inflation down, governments are going to have to do deliberate harm to their own economies. The fact that the sword is still wavering is causing the most consternation as what markets abhor above all else is uncertainty. It is understandable that they have been reticent to act until they really must as they know higher interest rates are the one traditional tool they have left and that risks strangling growth for a period to reduce spending and bring down inflation.
There is now some consensus that progress with the economy and markets will not happen without some certainty that policy is working. At the start of this week, Blackrock, the world’s largest fund manager, said “we don’t see a sustained rally until the Fed explicitly acknowledges the high costs to growth and jobs if it raises rates too high”. They went on to assert that the Fed (Federal Reserve) will eventually come round to the idea of living with higher inflation rather than raising rates to the level at which growth is destroyed.
JP Morgan also see the simple choice; tighten policy too much and cause a recession or allow a more relaxed situation living with higher inflation than they would like. This is perhaps a choice between dealing with inflation or protecting jobs and, given recent White House statements that they understand the concerns about jobs and the stock market and with elections upcoming, there would seem to be an increasing chance of having to accept at least for now higher US inflation.
Then on Wednesday we saw some more decisive action by the Fed, raising their interest rates by 0.75% the most in nearly 30 years. At the same time, they reaffirmed their plan to keep taking the support money out of the economy and also that higher rate rises would be used if required. The Chairman said that whilst the 0.75% rise was not normal, there would likely be another rise of perhaps the same amount next time. This initially gave a big boost to US markets, to only fall back on Thursday exactly as it happened last month after the Chairman last spoke. It may be a case of the initial euphoria dissipating, very short-term profits being taken or that the market right now lacks real conviction. This was the more decisive action that many economists had been calling for, just not the desired response in the very short-term.
On a similar note, the Bank of England increased interest rates here by 0.25%, though 3 of the 9 committee members wanted 0.5%. This is a much smaller rise than in the US reflecting the quite different relative strengths of the two economies. The European Central Bank, in addition to its planned rise of rates, has also signalled that it will introduce a mechanism to restrict the volatility of bond prices in the Eurozone. This will help reduce volatility across economies of different strengths and likely pave the way for more aggressive interest rate rises than the ECB has made to date.
Our summary is that we are likely to see heightened volatility and no meaningful upward progress until the real-world impact of those policies can be seen. In times of strong investor sentiment, it is often enough to see policy moves like this and extrapolate a positive outcome but right now it is a case of ‘show me don’t just tell me’.
It is also important during times of stress and quite natural concern, to avoid the temptation to automatically associate economic developments with the prospects for stock market returns. Weak economic news can make us fearful about markets, despite this link not being wholly reliable. Stock markets tend to look ahead and anticipate events whereas much news flow is based on what has already happened.
That said, we are very mindful of all that is going on and how that feeds into the best asset allocation to protect our clients’ money.
LGT Market Update
Next week we will provide a fuller commentary on our Sustainable portfolios following a meeting with the LGT Wealth team. The summary comments below show in outline the portfolio changes this year.
The backdrop, as we know, is that to date in 2022 both shares and bonds have fallen, knocking the logic of the traditional asset allocation where if one of the two suffers then the other compensates. If the year ended now, then this would be the first time since 1969 that both bonds and equities had fallen at the same time. This has created a painful environment for anyone with a balanced portfolio hence we have incorporated infrastructure, real estate and commodities across our Sapphire and Momentum portfolios.
LGT have reduced the exposure to the domestic UK market on account of fears of a slowdown in consumer spending following the rise in the cost of living. The exposure to the more expensively valued US technology sector, whilst retaining the quality end of this market, has also been reduced. In the bond market, which is now starting to look attractive with rising rates, the time period over which bonds have been held has been reigned back to get the best returns.
In turn, areas that have been introduced are cash holdings to provide protection and extra flexibility to act quickly on opportunities and also more robust assets such as those included in the Ruffer Diversified returns (which holds gold and other types of reduced volatility assets with the focus on capital preservation). The deciding factor on future changes will be when we see if the evidence points to inflation becoming more entrenched and here to stay at an elevated level.
Have a lovely sunny weekend.
Gus and the Investment Committee
Please Note: This communication should not be read as giving specific advice regarding your personal circumstances. This would only be given following detailed assessment of your individual needs. The value of investments may fall as well as rise; you may get back less than invested. Past performance is not necessarily a guide to future returns.