Please find below our Investment Market Update as at 18th February 2022.
Painting the Picture
Yesterday, I was invited to share my views to my fellow Board members at the Dorset Chamber of Commerce and Industry (DCCI), as part of the Board’s overview as to what’s going on in the business world. To provide perspective, it is always important to understand what’s happening globally and not just here in the UK. It was well received and so I thought I would share with you a summary.
I think I may have shocked a few with my forthright comments but I did make it clear that once we have ridden the storm (very apt today), good times are ahead.
I suppose it’s ingrained in me to point out that whatever I say should not be construed as financial advice, more guidance as to how we at Blue Sky see the economic and investment landscape unfolding, globally and on the shores.
Ok, what’s going on out there?
The simple answer is… lots. It seemed to resonate in the room when I described economic conditions as a washing machine of uncertainty with us being on a fast spin cycle right now!
A whistle-stop tour of the last two years
To understand what’s happening now, it is important to appreciate what has brought us to this point. Avid readers of my Market Commentaries will know verbatim what’s been happening but bear with me whilst I run through events.
Before the pandemic
It seems an age away now. Here in the UK, we had experienced lots of turmoil, partly because of Brexit, partly because of political turmoil and, of course, we had the UK elections on 12 December 2019. Whatever your politics, the outlook then seemed to be more positive with a majority government rather than a weak handed coalition.
Then came the pandemic!
This put paid to any economic recovery. We all know what happened and Covid-19 plunged us into an economic crisis. Central banks and governments avoided a catastrophe like the US depression in the 30s by acting quickly. Who’d have thought that so much good would have come out of the financial crisis in 2008-2009. Quantitative easing was part of our everyday language… at least in the financial arena.
So, we plunged into a what was described as the deepest recession in the last 300 years, yet because of the stimuli on many fronts, it was proven to be the shortest of all time. The cavalry was in town!
A consumer boom
Enter front and central the ingredients for a consumer boom. Most people had time on their hands, with many feeling better off. The building trade exploded and property became the hottest ticket in town.
Stock markets were on fire, especially tech orientated growth stocks. Happy days. Recession, what recession? All helped by the avalanche of money, low interest rates, improvement in savings and people having more time to think and reflect.
Hiccups but upward trajectory
With the delta variant of Covid-19 and then omicron, economic predictions were altered but the direction of travel was upwards for the global economy. The UK was particularly well placed with the vaccination programme being announced in Nov 2020 and economic forecast improved as did UK stock markets, having lagged their global counterparts.
The danger to the recovery
The bad apple in this recovery was the threat of tighter supply chains. Building materials were hard to come by, costs were rising and there was a pent up demand with people having to pay higher and higher amounts for materials like timber.
What really brought it home was the petrol crisis in October of last year. This is when supply chain issues were really brought into focus, as was the cost of rising energy prices, Brexit and labour shortages.
The storm was brewing but in truth it had been since mid-2020.
When I first joined the Chamber Board early last year, I remember talking about inflation and I warned of a steep climb in UK inflation. Little did we know that today’s inflation, here in the UK, would be 5.5% the highest in 30 years, nearly three times the government’s target and rising!
It’s even worse in the US. The annual inflation rate there accelerated to 7.5% in January 2022, the highest since February of 1982.
A rapid response or too slow?
Not helping inflation is China and the Far East. Whole rafts of their economies have shut down, with many provinces of China adopting zero tolerance.
Central banks around the world are really anxious about inflation and in many quarters, in hindsight, it is felt that authorities were caught with their pants down… too slow to begin raising interest rates. In the US, many analysts are predicting between 4-6 rate increases this year.
This explosion of rates in many quarters is deemed to be happening too quickly, akin to taking the patient off the oxygen suddenly… the question is, metaphorically speaking, how will the patient respond?
Stock markets have been hammered over the last 6 weeks
Especially the growth stocks, particularly tech companies which benefited in the early stages of recovery. Technology however is now deeply embedded into many companies. There has been indiscriminate selling and even those strong companies with good balance sheets and predictable earnings, like Microsoft, have been hammered.
It’s important to remember though that good companies don’t become bad companies overnight. Many of these companies don’t have tons of debt, yet they have been indiscriminately sold. Amazon for example has fallen by 30% or more eight times in the last 10 years but look at how the company has responded!
Bonds, normally safe havens when equities fall, have also been very volatile and have seen their values eroded. UK gilts have lost nearly 8% in the last 6 months. Bonds don’t like rising inflation and as they are fixed interest instruments, don’t like the bi product of rising interest rates.
Some stocks however have loved it
Those companies that have ridden the waves are energy stocks, oil and gas, broader commodities, and financial stocks, especially banks.
The FTSE 100 has therefore remained elevated, and the index is the standout performer amongst its peers, along with the Hang Seng Index. However, once again perspective is required. The growth on the FTSE 100, dividends aside, has only been 4.16% over the least 5 years!
It’s important to realise that the FTSE 100 is not representative of the UK economy as it’s a concentrated basket of stocks with over 70% of its constituents obtaining their earnings from abroad.
So, what can we expect moving forward?
- Interest rates will increase, possibly 4-6 times in the US
- Capital Economics, who undertake independent macro research are also predicting four interest rate rises in the UK this year. March is flagged as the next rate rise for the UK
- We expect to see a weakening of Gross Domestic Product (GDP) over the next few months as a result of restricted consumer spending
- Inflation will likely peak in the next 6 months. The Bank of England expects inflation to climb to 6% in February and March before peaking at 7.25% in April
- However, inflation is predicted to fall significantly into next year and with it, interest rates will then likely be lower. Although, it’s important to note that rates are unlikely to fall back to anywhere near all-time low levels
- The housing market will stall and property prices may weaken, depending upon location
- We believe supply chains will gradually begin to ease, especially when the Far East nations kick into action again
- UK employers are expecting to award pay rises of 3% on average this year according to a recent survey. Businesses that are struggling to fill vacancies are expected to offer the highest pay awards for over a decade, but importantly, in most cases, this will still be lower than inflation
- Many businesses have very strong balance sheets and have significant amounts of capital to deploy. It’s all about confidence of course. We believe we are moving from a consumer-led boom towards a business-driven boom, recognising of course that there are going to be short-term pressures on businesses
Stock markets wise:
This is really important for our pensions, company money and our own investments, along with the overall health of the economy
- A wider, more diversified portfolio is the name of the game. A combination of what is termed Growth v Value
- We are expecting many companies to increase their yields significantly which will likely attract investors towards so called value stocks
- Areas which we are excited about:
* The healthcare sector, good yields are a feature here, and this sector has also lagged other sectors in terms of performance, beyond the early months of the pandemic
* Commodities and rare earth metals will be in demand as the global economy recovers
* Sustainability (ESG) and money from governments, investment by businesses, increased regulation and the demands from consumers are key drivers
* Global themes… again investment form governments and businesses is key. We are talking about investments in e-commerce, robotics, artificial intelligence, genetics, water and waste management to name but a few
* Geography wise… China and the Pacific, Japan, Europe and the US are ones to watch. Interestingly, the UK now only makes up circa 4% of the MSCI world index. The UK is increasingly marginalised on the world stage, however there is no doubt in our mind, from a valuation perspective, that there will be very attractive entry points over the next six months.
We are enduring a vortex of uncertainty but eventually, economies and markets will find their equilibrium.
Corporate profitability is the key to stock market gains and the current economic dynamics have certainly put the brakes on forecasts. Stock markets are a forward-looking indicator and so no wonder we are experiencing turmoil.
What we don’t want here in the UK or indeed globally, is a shrinking economy combined with long lasting high inflation. We believe this is the worst case scenario. I’m pleased to say that we see the outlook through a far more optimistic lens with the global economy reopening and supply chains improving, which in turn will help ease inflation and take pressure off rising interest rates. This we believe will be beneficial to consumers and businesses alike.
Oh, and then there is the issue of Ukraine and Russia. Let’s hope this is resolved considerably quicker than the inflationary issues we face.
Thanks for reading.
LGT Vestra, Capital Economics, FE Analytics, Bank of England,
Investment Week, Bloomberg, FT.com
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.