“Though we see the same world, we see it through different eyes” – Virginia Woolf, Three Guineas, 1938.
2022 has started pretty much how 2021 started: amid plenty of uncertainty caused by a resurgence of new coronavirus infections.
Although this resurgence is unlikely to stop cheese and wine work gatherings, it is likely to disrupt supply-chains and hurt economic activity in the short-term as we voluntarily scale back our interaction to protect ourselves and others, or call in sick.
To be clear, we certainly aren’t trying to make light of recent events or this horrible surge in cases but a slowdown in economic activity does highlight the need for central bank policymakers not to get carried away with interest rate increases to curb inflation, despite the fact that over the valuation period (the three months between 5 October 2021 – 5 January 2022) a number of economists and journalists started to forecast that inflation will continue to rise and remain with us in a potential rerun of the 1970s!
As a consequence, financial markets are now expecting (and are therefore pricing-in) that interest rates will rise aggressively to combat this inflation.
However, we see things very differently.
Although we have long argued in our regular market updates that the rate of inflation will keep climbing in the coming months, we believe that we will see inflation peak during 2022 and then start to fall back towards central bank targets of 2% during 2023.
In fact, we wouldn’t be surprised if this time next year, we are talking about the potential for disinflation or even deflation – hence why we believe the path of any interest rate increases will be very shallow and the high point for interest rates well below historic averages.
While this view may appear contrarian, we believe that fickle economists and journalists (many of whom weren’t even born in the 1970s) are being too simplistic in their assumptions by focusing too much on the current energy bill crisis and supply-chain disruptions, which has led to shortages (and price rises) for food and goods.
In order to see a rerun of the 1970s inflation (when UK inflation hit 26.9% and averaged just over 12.5% during the decade), the price of energy, food and goods not only needs to stay elevated, but needs to keep rising strongly over the coming years.
We believe that this is unlikely to happen as the majority of these price rises are artificial, in that they have been caused by the coronavirus outbreak. With today’s just-in-time workflow and consumers’ demand for speed, supply-chains (involving cargo ships, ports, lorries, factories, warehouses and retail outlets) have intertwined and operate on very tight schedules – and these have seen significant disruption caused by both government lockdowns and staff shortages due to isolation requirements.
As such, aggressively increasing interest rates today won’t correct the current supply-chain disruptions and bottlenecks by providing more lorry drivers or increasing capacity at the world’s ports. Nor will it increase the capacity for semiconductor production or relieve the global energy crisis.
And with governments around the world appearing to be reluctant to reimpose strict lockdown restrictions, coupled with the vaccine rollout, stoppages due to coronavirus outbreaks should start to become a thing of the past allowing the current artificial supply shortages to clear and prices (and therefore inflationary pressures) to subside – hence why we see potential deflationary forces.
Moreover, in the UK, in addition to having to contend with higher energy prices, we will also have to deal with higher taxes from April, which will squeeze UK household incomes further. And as the consumer accounts for around 60% of the UK economy, the Bank of England (BoE) would put the economic recovery at risk by aggressively increasing interest rates.
Consequently, we believe that economists, in forecasting aggressive interest rate increases, have actually given us a massive reason to be positive on global equity markets: when central banks don’t aggressively increase interest rates and monetary policy remains accommodative, global equity markets should get a boost, especially as we see nothing else which would suggest that the global economy can’t continue to grow and prosper.
Income Element
Given we believe that financial markets are wrong to price-in the prospect that the BoE will increase interest rates four times during 2022 (we believe any further interest rates increases will be measured and gradual), our focus on a diversified spread of secure companies with investment grade credit ratings and stable income continues to look sensible.
Long-Term Growth Element
Global equity markets have been skittish over the valuation period (annoyingly, the path for global equities is never simple, smooth or easy) – and unfortunately, we believe this elevated market volatility is likely to continue as the market is currently trading on every news headline or central bank policymaker comment.
While we fully understand and appreciate that this volatility may be unsettling, long-term investors need not be concerned as ultimately we believe that the path of least resistance for global equity markets remains higher – and please remember that my wealth are here to help you with any portfolio queries or concerns you may have, while our Investment Advisers can provide you with regulated financial advice, should you need it.
During the valuation period, the most notable change was the switch out of a long-term holding in the BlackRock Asia Special Situations into Crux Asia ex Japan. The BlackRock fund has recently changed its strategy and had become more defensively positioned than we would like, given our positive outlook on the region (many Asian and Emerging Markets countries have been slower to rollout coronavirus vaccinations than more developed countries, but as these vaccination programmes catch-up, their economies should reopen and recover strongly). The Crux fund’s strategy is less likely to flip-flop – and so gives us a more reliable growth-focused position which blends well with the other funds held in this region. Furthermore, we were able to negotiate an extremely attractive share class, with an ‘ongoing charges figure’ less than half of the BlackRock fund.
In the UK, we exited DS Smith (a provider of corrugated packaging and paper products). Although the longer-term structural growth opportunity for packaging remains positive, we were concerned about rising costs (particularly energy). Additionally, we increased exposure in Ashtead, an equipment rental company, serving construction and industrial customers in the US, UK and Canada.
Investment Management