Commentary on December 2021
Despite a challenging start to December, with the Omicron variant spreading rapidly, equity markets enjoyed strong gains. Stock-markets in the United Kingdom and Europe rose by over 4% and although the US lagged with ‘only’ a 2% gain, it hit record highs towards the year-end. Asian markets enjoyed gains of around 2.5% but Japanese and emerging markets were flat. Government bonds continued their rollercoaster ride losing around 2.5% with the Index-Linked variety falling 5%.
Data showed a continuation in global economic growth, albeit at a more subdued pace than earlier in the year. Globally, manufacturing reported an acceleration in output, new orders and employment, while business optimism data indicated that companies expected output to rise further over the coming year. However, within the survey, some countries were affected more than others by Covid-related lockdowns, supply problems and rising energy prices. The service sector reflected the contrasting fortunes of the United States, with activity at record highs, with mild slowdowns in the UK and parts of Europe, hit by the early and rapid spread of Omicron.
The economic data most in focus, employment and inflation, remained unquestionably strong; the rates of unemployment in the US and UK dropped to 4.2% in both cases. Inflation remained the hottest topic with headline rates hitting 5% in the UK and Europe and 6.8% in the US. Although many countries showed price rises in the 2-4% bracket, Turkey took the honours with a rate of 36%, 14% of which reflected rises in December alone!
Having teased/ misled markets a month earlier, the Bank of England was first to react by raising interest rates to 0.25%. The US Federal Reserve then dialled up the rhetoric in announcing that it would speed up the tapering of bond purchases, with the implication that this could bring forward the first rise in interest rates to this coming March. Minutes from the latest meeting reported some members wanting to bring forward Quantitative Tightening, that’s a big step further than just reducing the purchase of bonds.
Moving into 2022 the focus is on whether central bank monetary policy can steer the economy between the future unknowns of the Covid pandemic and the transitory or persistent nature of inflation. While the number of Covid-related deaths continues to drop, the disruptions to economic activity from absent employees and possible further government restrictions remain a concern for investors. Next month’s data will shed more light on how badly Omicron affected the work force and consumer spending in December but currently, New Year optimism favours the view that, going forward, Covid variants will become more flu-like and less of a strain on the economy.
The debate over whether inflation is just a longer form of transitory or becoming more deeply embedded will rage on for at least the first half of the year. We don’t know the answer but remain of the view that markets still haven’t priced in much of a risk. The market expectation is for interest rate rises in the US and UK during the first quarter of the year, and for a further three this year in the US, yet the UK 10-year gilt still only yields a touch over 1%. Fed’ Chair, Jerome Powell, recently stated that inflation would stay high until mid-2022 (that’s 1 year later than his original forecast!).
There remains a big risk of policy error by the central banks in either direction. For now, the risk remains that they are already late to the game in tackling inflation; the consequent risk could be one of over-tightening policy just as some of the inflationary culprits work their way through the system.
Interest rates are starting to rise, but cash and bond yields are a long way below inflation. Those with cash savings will see the real value of their money diminish unless they can find investments offering higher returns. In our view, 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?
An autumnal pullback provided the opportunity to increase exposure to value in the UK. 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.
We remain underweight fixed interest; in the portfolios that require bond exposure we favour those funds linked to inflation or rising interest rates and with limited exposure to rising yields.
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.