This update should not be taken as advice. If you are unsure about any of the content please contact your financial adviser. Please remember that the value of stock market investments will fluctuate and investors may not get back the original amount invested. To assist, where appropriate, a glossary explaining some of the terms used has been provided at the end of this update.
A few months ago the major regions and countries around the world were fairly well synchronised as to where they were in the economic cycle, if we can still call it that. However, as time has moved on central banks have focused more on domestic issues than global ones, which is unsurprising and therefore we are seeing some differences in the implementation of policy. The first half of the year was dominated by the associated macroeconomic factors of sharply rising inflation and rapidly tightening monetary policy. Will this continue through the rest of the year?
Back to the future
It has been so long since we have experienced inflation like this in developed countries that economists have had to turn to their history books for comparisons and there is lots of discussion about how many fund managers have actually got experience of such conditions; to which the answer is very few.
I am not sure that matters terribly, mainly because each economic cycle is different. They do have common features, but have many differentiating ones as well. Previous periods of high inflation may have been triggered by high oil prices, but they were not also associated with 10 years of ultra-loose monetary policies driven by a global financial crisis, turbo-charged by the need to provide massive economic support during a global pandemic and its consequences.
The current economic backdrop is more about now, than it is the past.
The policy tightrope
As inflation has headed towards double digits in the US, UK and Europe, central banks have increased interest rates and tightened other monetary policies to try and stem its inexorable rise. As we went through April and May, there was hope that each month would see inflation peak and we will hope the same for June when the data is published. I fear we will be disappointed.
The US Federal Reserve Bank, Bank of England and European Central Bank have very difficult balancing acts to pull off in managing inflation down without pushing their economies into recession, which is why they are increasingly domestically focused; another sign of deglobalisation, maybe?
No central bank has ever had to deal with a set of conditions as they face at present. Every statement they make, every decision they announce and any guidance they give, will be scrutinised to such an extent that the opinions of analysts will no doubt be poles apart, with every point in between covered as well. Every release of economic data in all major regions will be poured over and move financial markets.
Key drivers of prices
There are many factors that drive moves in financial markets which include; macroeconomic (such as interest rates, inflation, economic growth, and employment), valuation (how cheap or expensive prices are relative to history and other investments), sentiment (how investors view future prospects), sectoral (how a particular industry is faring) and stock specific (how a particular company or other investment is faring). Each one of these, and others, will have a different scale of influence at different times. The first half of this year has been all about the macroeconomic influence across all asset classes.
In some ways that makes it easier to manage investment funds, as you are aware of the major influence, but overall, it makes it harder. A company could be operating very well in a sector that is growing, be well thought of and look cheap, but its share price may well have fallen because of fears over inflation and interest rates and the broad stock market has fallen.
Furthermore, and perhaps most importantly, investors look ahead and when the outlook is uncertain, as it is now, they will often opt for safety rather than taking risks. All of this has led to volatile market conditions in most asset classes and, overall, lower bond and equity markets, on quite some scale.
Thanks for the history lesson
It is normal to write reviews of what has happened in economies and financial markets; we should explain what has happened to your investments and our fund managers do the same for the individual funds. This update note aimed at being more big picture and the next obvious topic to address is; what happens next?
Well, I wish I knew! Perhaps the best way to address the question is to look at individual asset classes, as they should perform independently.
Before stating a brief run through of the major ones, I should point out that I could, quite easily, make a case for not owning any asset class at present, but we need to stay balanced and long term in our views.
My word is my bond
No major asset class is homogeneous in nature. Bonds vary from the very safe (such as those issued by the US, UK or German governments) to very risky (those issued by badly financed companies). However, the level and direction of travel for inflation and interest rates impact them all to one degree or another. It will be of no surprise that bond markets have been weak this year. Given the outlook, why would you want to invest in bonds now? Good question.
Well, they have fallen so far that they are discounting a fair amount of the rising inflation and interest rates to come. If you are willing to look long term and believe that inflation will be tamed, you will be able to see the peak in the interest rate cycle. If you are willing to take the risk that bond markets may go lower in the short term, then some investors may believe it’s time to think about buying them in a modest way and with a low risk approach for now.
Stock markets or a market of stocks?
Much of what I said about bonds applies to equities as well. Particularly the bit about the diversity of the asset class. At Premier Miton, we are active investors, so in the main we do not buy investments that track asset classes or indices. This means that our exposure to stock markets is selective and targeted. This is usually through individual companies selected for their attractive characteristics. There are sectors, such as real estate, infrastructure and utilities which can benefit from inflation. There are also sectors that are in long term growth trends, such as technology or healthcare, that provide opportunities.
It is very important to try to avoid companies whose profits may suffer from slowing economic growth and very important to focus on the valuation of their shares.
That said, we see lots of opportunities across the range of our funds at present; again, for the long term investor.
Oil, gas, copper, aluminium, iron ore, silver, wheat, corn, sugar, coffee, cattle …. etc
Commodities are even more diverse. The prices of commodities are very much driven by demand and supply. The most obvious examples to give are oil, gas and wheat; the supply of these has been severely interrupted by the war in Ukraine and prices have spiked. I am no expert on commodities, but it does look like prices could remain high. Are they worth buying? I don’t know, but they are risky and volatile markets.
Gold is the odd one out here. Convention has it that the price of gold should go up when inflation is rising, also that in uncertain times it is thought of as a “safe haven” asset, which is also beneficial. The price of gold has been volatile this year, but is largely unchanged, which I find difficult to explain. Looking ahead, and through inflation and potential economic recession, it is possible to be pessimistic on the price of gold. But I’ve been wrong before!
The last word
In the short term; inflation is very likely to stay high and interest rates will go up, economic growth will suffer and recession may be imminent.
In the longer term; inflation will moderate, interest rates will come back down and economic growth will resume.
Financial markets reflect the outlook, partly the short term and partly the long term. We invest for the long term, but consider the short term in our decisions