Commentary on April 2022
Investment markets edged lower as economic growth and rising inflation weighed heavily on sentiment. Interest rate rises in the United States and United Kingdom were as expected but the accompanying central bank statements added to market volatility. Stock-markets in the US and Japan fell by over 4% in sterling terms, Europe and emerging markets fared better at just 1% lower and the UK showed marginal gains. Government bonds fell by between 2-4%.
Economic data in general confirmed continued growth but at a slower pace than immediately post-lockdown and with the service sector taking over from manufacturing. Employment data remained strong in the US and UK, but the European jobs market had stalled since the invasion of Ukraine. Activity in China remained hampered by Zero Covid lockdown measures, which also affected supply issues abroad. Headline inflation continued to surprise to the upside, recording modern day highs. The average annual rate of inflation across the developed world, at 8.8%, is the highest since the 1980s. The US report of 8.3%, released in early May, was slightly lower than the previous month but higher than forecast. These data provoked multiple interest rate rises and plenty of tough talking from leading central banks.
The US Federal Reserve raised interest rates by 0.5%, the biggest hike in 22 years, and gave a strong indication that they would consider similar rises in both June and July. Fed’ Chair, Jerome Powell, also announced that they would begin the process of reducing the bonds on their balance sheet that had accumulated through quantitative easing in June. The US stock-market initially reacted well to these announcements, adding over 1000 points post-statement, but these gains quickly reversed.
The following day the Bank of England increased its bank rate by 0.25% to 1%. This was in line with expectations but the accompanying Quarterly Inflation Report shocked markets; the Bank warned that they expected the UK to fall into recession towards the end of 2022 and at roughly the same time for inflation to peak at around 10%! In addition, the Monetary Policy Committee will now consider the process of selling down its government bond portfolio (quantitative tightening) built up through the Asset Purchase Programme, though this doesn’t look to be imminent.
We’re seeing a dichotomy between the United States and other economies. The recent rise in US interest rates was preceded, accompanied, and followed by tough rhetoric from Fed’ members, talking of the need for more rate increases-a single rise of 0.75% was widely discussed, though dismissed by the Fed’ Chair in his recent comments. The view is that the American economy is in rude health and is one of the few economies that can withstand a barrage of rate rises. With mid-term elections approaching, political pressure favours ‘tough on inflation’ even if equity markets suffer. As a sidenote, Jerome Powell hasn’t yet been confirmed for a second term as Fed’ Chair-until then, at least, he’s likely to talk tough.
In stark contrast, the Bank of England was almost apologetic in announcing a rate increase, saying that ‘Further increases may be necessary, depending on what happens in the economy.’ It then went on to describe how the new fiscal measures, energy price-cap rises, and the general cost of living would squeeze the economy, leading to negative growth towards the end of this year and into next year. The tricky bit here is that the correct course of action would be to rein in the rate increases-except that the Bank’s forecast is that, subject to an October increase in the energy price cap, inflation could hit 10%, also around the year-end.
This is all benefiting the US dollar with higher and rising rates making it attractive, as well as an economic safe haven. And on the flip side, sterling has collapsed on recession fears, the euro isn’t far behind on worries over the escalation in Ukraine, and the Japanese Yen has been hammered because of its crazy policy of capping bond yields at a level not commensurate with global bonds or inflation.
For balance, there’s a lot of bearishness already in the market with Ukraine continuing to impact supply chains, central banks balancing recession worries with rampant inflation and China two years behind the rest of the world with lockdown measures. The great unknown is how the world will cope with a background of tightening money instead of low rates and the backstop of central bank buying. However, the returns on cash and bonds remain at extremely low levels and well below the current levels of inflation. We expect market volatility to continue, and remain of the view that a diversified portfolio, favouring equities over bonds, remains the best way of producing inflation-beating returns over the long term.
How are we currently positioned?
We feel that in the near-term bond yields have risen too far, given the genuine fears of a slowdown, and consequently we added a position across our low and medium risk models. There has already been a sharp rebound over the past few days and if this continues, we will reduce our corporate bond holdings.
We are currently looking at a few new funds in readiness for when the markets present a good entry level.
Our portfolios diversify risk by investing in a wide range of assets using actively managed funds with sound investment processes. Some examples of these ‘alternative’ assets are funds invested in gold & silver, infrastructure, agriculture and absolute return strategies.