Commentary on October- November 2021
FESTIVE GREETINGS FROM CHARLWOOD’S
Stock-markets moved higher through October but whip-sawed downwards towards the end of November as the emergence of the Omicron variant hit markets that were partially closed for US Thanksgiving. Over the 2-month period, and in sterling terms, stock-markets in the United States rose by around 8%, boosted by the strong dollar; other markets were broadly flat except for Japan, which fell over 4%. Fixed interest bonds were mixed with corporate and junk bonds reflecting the nervousness in equity markets whilst UK gilts rose by over 4% with the index-linked sector gaining 10%.
The interpretation of economic data didn’t get any easier; output and growth reports were mixed around the world with China noticeably slowing but growth elsewhere expanding, albeit at a slower pace. Data on jobs and inflation were, however, more emphatic. Employment data in the US, EU and UK showed greater numbers returning to work, despite the ending of furlough schemes, and record number of vacancies for new jobs. Inflation continued to hit multi-year highs; year-on-year consumer price inflation exceeded 4% in the UK and Eurozone and remained over 6% in the United States.
Bond traders suffered a torrid couple of months as central banks in the US and UK ‘war-gamed’ their inflation scenarios in public. The Bank of England was first to warn that they were concerned with above-target inflation and that the UK should brace itself for ‘significantly earlier’ rises in interest rates. This was taken as a nod towards a rise at the November meeting, sending bond yields higher. In the event, members voted by 7-2 to maintain rates at current levels leading to a vicious reversal in bond yields and a fair amount of flack directed at Governor Bailey for misleading the market.
In the United States, President Biden re-nominated Federal Reserve Chair, Jerome Powell, for a second term but with member Lael Brainard as his deputy. Over the course of two months the Fed’ moved from signalling that a start to tapering bond purchases, but not interest rate rises, was imminent, to admitting that it had under-estimated the strength of inflation to the point that the word ‘transitory’ could ‘be retired’. Chair Powell’s latest speech suggested that the tapering program could be increased in size and wound up a few months sooner than previously expected.
The epitome of consistency, the European Central Bank ‘recalibrated’ their bond purchases a tad lower but didn’t even contemplate future rises in rates, despite the highest inflation since the single currency began.
Up until US Thanksgiving Day, the narrative had simplified-there was general agreement that although inflation may yet prove to be temporary it currently warranted attention from central bankers. The questions were more about how soon to start raising interest rates and where the rate cycle was likely to peak. Then at the flick of an Omicron switch the bond market surged to price in a postponement of likely rises, deeming them too risky if the world entered various degrees of lockdown. Whilst we can’t predict how central bankers or politicians will react to this latest outbreak, there are a few points we find relevant to the interest rate debate:
Interest rates were cut to record lows in early 2020 as an emergency act in response to the uncertainty created by the onset of the Covid-19 pandemic. It’s reasonable to suggest that the same level of panic no longer exists and therefore some, or all, of the emergency cuts should be reversed.
Relying on economic data will remain tricky for some time due to the comparison to base effects of activity during the pandemic. Also, as we’ve mentioned before, we can’t yet tell whether a ‘slowdown’ in growth is due to slowing demand or simply because supply constraints mean that orders can’t be met. Raising rates can’t build cargo ships or produce semi-conductors, but they can signal to investors and workers that central banks are alert to inflationary pressures.
Any assessment of Omicron and its consequences is highly conjectural right now. Its discovery simply adds to the unusually broad spread of possible paths for economic activity, inflation and interest rates. As things stand, there’s been a change of emphasis in Fed’ thinking, with members showing more anxiety over rising prices than missing employment targets.
Several gauges of inflation expectations suggest a belief in the transitory theory, but over a longer time period. In the bond market, flattening yield curves and forward inflation breakeven levels (apologies for the jargon) suggest that investors don’t think that inflation will endure much past five years. Less mathematical surveys of consumers support this belief.
Over the longer term we believe that interest rates are unlikely to offer a return above inflation. Equities will remain volatile, but a diversified portfolio offers the best prospect of producing long-term gains.
How are we currently positioned?
An autumnal pullback provided the opportunity to increase exposure to value in the UK, where our preferred vehicles are Artemis UK Select and MAN GLG UK Income (the latter for income portfolios), along with the existing bias to small and mid-cap stocks. Elsewhere, exposure to Japan and emerging markets has been increased; these are also value-orientated markets that have lagged recent trends favouring the US and its more glamourous growth stocks.
Overall risk has increased slightly, in line with the increased exposure to equities.
Existing holdings in Troy Trojan and Unicorn UK Income (the latter on our income portfolios) have been switched into their ethical versions. ESG is an important theme, and we will continue to seek out individual funds in this area that fit with our overall strategy.
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.