Please find below our Investment Market Update as at 24th June 2022. Today’s communication is written by Andrew Dunn (Gus) as Gary is on holiday.
Blue Sky Investment Market Update
This has been a relatively quiet week with little fresh news to add to the debate.
The Chairman of the US Federal Reserve had his regular grilling by the Senate Banking Committee but anyone hoping for a clue on the direction of interest rates was disappointed. It is to be expected that he is effectively saying let’s wait and see, with so many dynamics around inflation, employment and geo-politics constantly moving. What he did say when directly asked, was that whilst a US recession was always possible, he did not see the risk as elevated, with companies, the economy, and the public in good financial shape.
A slight encouragement to inflation was his comment that inflation in the US was more related to demand, which means that rises in interest rates were very likely the right medicine. The contrast in Europe and the UK is that inflation is more of a supply issue (energy and food costs) and much less likely to reduce with higher interest rates.
We are increasingly seeing governments looking to support the public and support household income. Here in the UK, it is proposed that the triple lock will be restored to state pensions, which could lead to a 10% rise for pensioners. This is in addition to other targeted support around energy bills. In the US, President Biden is hoping to suspend the gas tax to reduce the price of fuel. Europe has also supported its populations with various measures. This is designed to be seen to be doing something, support consumer demand, which in turn helps the economy and of course carries political favour.
Just to reiterate our previous commentary we are now in a holding pattern, with, in the absence of any unexpected events, investors waiting to see if inflation moderates and allows interest rates to rise only moderately. This will be as a result of central bank actions, commodity prices easing and the increasing caution of consumers to reduce their own spending. To use an analogy from Game of Thrones, we now have a story of fire and ice, wondering if the freezing effect of higher interest rates will damp down the fiery inflation that we are all experiencing. This is likely to take a number of months with a fair amount of volatility along the way, up and down. Morgan Stanley summarised this well stating they see a fundamental shift to a new economic cycle, ‘we have had our first pandemic in 100 years, our first invasion in Europe in 75 years and our first inflation in 15 years… and this signals a paradigm shift and a new era’.
As ever there will be both winners and losers and the key will be to identify the most resilient sectors. Please see below an update on investing Sustainably and in Asia. As you know we also favour infrastructure and prudently managed, cash generative businesses.
Outlook for 2nd half of the year
However well informed anyone is, the tide of negative news and falling asset prices are unsettling. Gary is back from holiday next week and in the next couple of weeks has meetings with all our investment partners so you can expect a detailed outlook. In the meantime, the following notes are a summary of the mid-year investment outlook issued by JP Morgan Investment Bank:
- Our central scenario is that a severe global downturn will be avoided
- Central banks will moderate the pace at which they tighten (interest rates rises less than thought)
- Bond prices are back to offering good value for investors
- Company earnings will grow modestly
- Infrastructure, real estate, and stocks offering resilient high dividends will remain attractive
Meeting with LGT
We had the chance to meet with Phoebe Stone and members of the LGT team and hear their latest thinking and portfolio positioning. In addition, there are more detailed comments on their position on investing in Asia, covered below. During periods of volatility, it is really reassuring to hear about and be reminded of the thoroughness of their processes and the research they undertake. Of course, their central summary of the current market situation was aligned with our comments over recent weeks about inflation and the next steps which central banks are employing to combat it. It was interesting that LGT saw a fair possibility that the current plan of interest rate rises in the US could be put into reverse by next Spring to be more supportive of the economy.
They felt that some of the Fed Chairman’s recent comments about inflation control being more important than economic growth, was deliberate tough talking to let everyone know his thinking. They cited shipping container costs, halving from their peak and some other commodity prices likely to soften as encouraging early signs on inflation.
The investment team at LGT were continuing to focus on areas that they feel will be resilient right now and avoiding those that they believe will remain under pressure. To this end, they continue to hold no direct investment into Europe, which has more challenges than most, and will avoid businesses that are overly reliant on discretionary consumer spending, without the benefit of strong cash flows and predictable earnings. They have also been reducing the UK element of their portfolios.
Investing Sustainably has been a challenge this year with performance lagging many conventional funds, as they have no direct money invested in the areas that have held up best in 2022 such as oil companies and defence. Many fantastic businesses are now priced well below fair value and do not represent the potential they have. We have before focussed on what a great underrated business Microsoft is, one of the largest Sustainable holdings but in amongst many less well-known companies are names such as Legal and General, Glaxo, Visa, Unilever, Intel, SAP and Standard Chartered. Quality companies across a range of industries that will prosper over time.
The rise of Asia
We are constantly seeking markets and geographies to invest in, that right now offer the best value. The following is an overview of the opportunities and actions taken by LGT to invest in Asia. In addition to the LGT allocations, we also hold this region specifically within our Momentum portfolio, as a constituent within the Legal and General index funds we have within the Sapphire portfolio and on an individual company level within a number of our other portfolios.
Since April, Asia and Emerging Markets have outperformed global markets, relatively speaking. This has been due to:
- Easing of lockdowns in the region
- Economic policy differing from the approach of the West
- Potential peak of regulatory crackdown on fintech
As we approach the halfway point of 2022, it has undeniably been a tough period for stock markets around the world. With that being said, we can find some pockets of relative outperformance. In the last couple of months, Asia and Emerging Markets (EM), and more specifically China, have been an outlier. This certainly was not the case last year, however, and some reasons for this recent surge in performance are outlined below.
Easing of lockdowns
The obvious one is the removal of the two-month lockdown across a swathe of cities in China. These were much stricter than those experienced in the West and some respite from these has spurred on investor confidence. Nonetheless, their zero-COVID policy may mean that the freedom of citizens will again be revoked, highlighting the risk/reward payoff of investing in the region.
Economic policy and data
Economic data, such as turning in the credit cycle, suggest the Chinese economy is already in an upswing. Though this was stalled somewhat by the lockdown, this has begun filtering through to markets.
Monetary policy is starkly different to the rate hikes we’ve seen from central banks in the West – with the Federal Reserve, Bank of England, European Central Bank (pre-announced for July) and even the Swiss Central Bank commencing their rate hike cycles. The goal from the western world is to rein in inflation, and in turn, put the brakes on economic growth. Conversely, China is looking to stimulate an economic rebound following their lockdowns.
On fiscal policy, the Chinese Communist Party (CCP) have announced a range of new measures, including new infrastructure spending, tax breaks for businesses, incentives for car sales, an easing of loan terms, cuts in mortgage interest rates and instructions for banks to increase lending. All policies point towards an economy embarking on expansion.
Peak of regulatory crackdown?
There are a few signals that the peak of regulatory pressure from the CCP has likely passed. Chinese tech stocks plunged last year following a regulatory crackdown from the CCP. Many are now trading at incredibly attractive valuations and prove a good entry point for long-term investors looking to reap the rewards.
One of these signals is fintech company, Ant, receiving a ‘tentative green light’ for an Initial Public Offering (IPO). Ant had planned an IPO in Shanghai and Hong Kong in November 2020; however, China abruptly suspended the deal days before the stock was due to start trading. This marked the start of a regulatory crackdown to suppress the growth of China’s technology sector at the time and could signal the end of the significant regulatory action this time around.
In the IPO market, total fundraising from offerings in China has hit almost $35bn this year, compared with just $16bn on Wall Street. IPO proceeds have fallen elsewhere due to the war in Ukraine, rising inflation and rate rises – all of which China seem to be relatively insulated from right now.
The impact on markets
Up to 20th June, the MSCI Asia Pacific ex Japan is down just under 13%, MSCI EM down about 14% and the MSCI World down over 20%. When looking at China A Shares versus the S&P 500, you can see where the sentiment begins to shift towards the region and has since usurped the US market YTD.
MSCI China A Shares Onshore Index vs S&P 500 YTD
Source: FE Analytics
LGT WM Model Portfolios
In the LGT WM Balanced portfolio, we have:
- 5.3% allocated to Asia EM equities,
- 3.4% allocated to Developed Asia, and
- 2% in China.
For some of the reasons highlighted, we prefer to take advantage of the price weakness of Chinese tech in the higher-risk portfolios, adding Allianz All China to the Growth and Adventurous portfolios in April. This is a flexible strategy investing in both the onshore and offshore Chinese equity markets. China’s onshore market is mainly made up of A-shares, while the offshore market is predominantly H-shares and American Depository Receipts (ADRs). We see this fund as a one-stop shop for long-term exposure to the full Chinese equity markets. The A-share portion of the fund can add an element of diversification to a portfolio and has historically had low correlation to the wider global equity market. Since its addition to the portfolios, it has been a strong driver of returns, delivering 10.6% to 20th June.
Have a lovely 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.