Over the last valuation period, the dreadful war in Ukraine and its consequences have exacerbated inflationary pressures and resulted in a cavalcade of hawkish central bank comments, as global equity markets sold-off.
We appreciate that talk is cheap, but we’d like to say that we believe it is best not to get caught up in the day-to-day noise of the media or the market, as that can lead to rash decisions – and whilst we fully understand that the current news headlines are negative, and market volatility is unpleasant, it is important to maintain a long-term perspective as markets often tend to overshoot on the downside in the short-term – the path for financial markets has never been smooth or easy and it is therefore imperative that one maintains a long-term perspective.
We mentioned hawkish central bank comments earlier – the world’s most major central banks have a single mandate – to ensure inflation remains low and stable (typically around 2%). CPI inflation is currently running at 8.6% in both the US and Eurozone; and 9.1% in the UK.
Due to this, we’re seeing markets price-in aggressive increases in interest rates, despite a deteriorating economic outlook. Whilst we appreciate that recent inflation may justify increases in interest rates, we believe that these forecasts are way over the top – we believe there is a clear limit on how much central banks can actually increase interest rates without adding a negative impulse to an already weakening economy.
Why is that? It is imperative to reiterate that the inflation we’re experiencing isn’t a result of excess demand, but due to supply-chain disruptions caused by coronavirus and exacerbated by the war in Ukraine. This type of inflation cannot be controlled with higher interest rates.
Furthermore, for inflation to remain elevated, the current supply chain issues would need to worsen and the oil price would need to continue to rise sharply, both of which we believe are unlikely.
We believe that we will see measured and gradual interest rate increases, and that inflation numbers will peak later in the year, and fall back sharply into 2023 of their own volition, without the need for central bank aggressive interest rate increases.
The good news is that the market appears to have got caught up in its own narrative. We believe the global economy will be unable to handle the aggressive interest rate increases that financial markets are currently expecting (and therefore pricing-in). Consequently, we believe that it won’t be too long before the market starts to anticipate a pause and then a reduction in interest rates – which should be supportive for global equity markets.
Looking at our portfolios, we continue to like UK equities. Given around two-thirds of the FTSE-100’s total revenue is derived from abroad, the majority of the companies in your portfolio will be relatively well shielded from the approaching UK recession, whilst the weaker pound provides a tailwind for exporters and those companies with significant overseas earnings.
During the valuation period we reduced some of the exposure towards Europe and used the proceeds to increase holdings in Asia and Emerging Markets as we believe these regions will survive the vicissitudes of the global economy and remain a good long-term growth story due to positive demographics and a growing middle-class population.
Regarding our ethical portfolios, the performance was unfortunately disappointing due to the strong relative performance of oil & gas companies which are underrepresented in the underlying ethical funds.
Fixed Income prices suffered steep declines over the valuation period as yields rose – and are now pricing-in a very aggressive set of interest rate increases.
This is contrary to our expectations: we see a more shallow and shorter interest rate path given the economic backdrop and weaker consumer confidence.
Consequently, we believe the Bank of England will soon start to walk back its hawkish rhetoric, meaning yields will fall and prices (which move inversely to the yield) will rise.
For a bit more detail on the matters raised, please refer to your latest valuation statement.
Investment Management Team
All information accurate as at 06/08/2022