Commentary on May 2022
Sharp falls in the early part of May, as investors reacted to poor earnings guidance from some US retailers, reversed towards the month end, leaving stock-markets barely changed. One of the broad US share indexes narrowly avoided falling into ‘bear market territory’ (technically a fall of 20% from the peak); this was greeted with relief by investors who called a (temporary?) bottom to the market. Stock-markets closed the month flat in the US, Asia and many emerging markets; larger companies in the UK and Europe made small gains but shares in smaller companies fell on growing fears of a recession. Fixed interest bonds fell by 1-2% with longer-dated index-linked bonds falling by around 5%.
Purchasing Manager Indices suggested ongoing economic growth, albeit at a slowing pace as supply issues, rising costs and geo-political uncertainty led to subdued order books- this was more marked in the UK than abroad. Unemployment fell further with unfilled vacancies hitting record levels in the United States. Inflation fell slightly in the US but the headline rate across the US, UK and Eurozone was consistently above 8% on an annual basis. There was better news from China, who announced an easing of lockdown restrictions and a desire to stimulate the economy.
US retailers Walmart and Target spooked the markets with cautious earnings outlooks, suggesting that they were struggling to pass on rising costs to consumers. Target subsequently announced a further cut to its profit outlook, saying that it would raise prices to offset higher costs.
Jerome Powell was confirmed for a second term as Chair of the US Federal Reserve, using his acceptance speech to reassert the likelihood of consecutive 0.5% interest rate rises at the June and July meetings. He also admitted that, with hindsight, it might have been better to have raised rates earlier! European Central Bank President Lagarde broke with convention to explicitly warn that interest rates would be returned to zero by the end of September; with European rates currently negative, this implies two 0.25% rises, starting in July.
The scenarios being debated by market participants are stagflation and recession, with throwaway comments relating to the feint possibility of a managed slowdown. The concern is that any period of further growth would be inflationary and so central banks will keep raising rates until growth disappears. Taking this a stage further, evidence of continued growth is being read as unwelcome news as this will provoke further rate rises. On the other hand, any moderation in growth would be seen in a more positive light, raising hopes of a soft landing.
Recently published Composite Global PMI numbers point to a very mild expansion in activity, but the manufacturing sector figure is below 50 (indicating a contraction in activity), whilst new orders are only just in expansion territory. Things look starker in the UK where a confluence of factors are causing a cost-of-living crisis. Although the job situation remains rosy this is a lagging indicator. More telling has been the slowdown in consumer spending as incomes are diverted to essential supplies. The problem is that, on top of higher taxes, rising energy and petrol costs push up the rate of inflation but also act as a further tax on disposable incomes, leaving less for discretionary spending.
Last year was about companies being able to pass on price increases; this year changing consumer spending habits and substantially higher gas and other commodity prices are hitting margins. There is a school of thought that this has already been allowed for in market valuations, but the 30% fall in Target’s share price on a negative update suggests that there is scope for further downside. There are many known negatives dominating financial headlines, and few positive arguments. We expect market volatility to continue and we remain open to the possibility of a further decline. But with investment ‘risk off’ positions anecdotally at extreme highs there is also a risk to being out of the market if some of the worst scenarios don’t play out. We 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 used the mid-month rally in fixed interest bonds to sell one of our corporate bond funds.
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.