Neil Birrell
Chief Investment Officer
For information purposes only. Any views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Investing involves risk. The value of an investment can go down as well as up which means that you could get back less than you originally invested when you come to sell your investment. The value of your investment might not keep up with any rise in the cost of living.
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A month is a long time in monetary policy
When I wrote this note in May it discussed the forthcoming June central bank meetings in the US, Europe and the UK. Events played out much as expected in the US; a 0.25% increase in interest rates and the possibility that we might be at the peak. In Europe, the outcome was as anticipated; a 0.25% increase and the likelihood of further increases.
The UK was the surprise package, with the Bank of England (BoE) throwing a “rate grenade” at worryingly high and sticky inflation numbers, by putting up interest rates by 0.5%.
Not many tools in the toolbox
The action of the BoE has sparked much debate, with politicians, economists and everyone else having their say. Opinions vary from; the action was necessary in order to beat the spectre of ongoing high inflation to the view that it was totally unnecessary and a meaningful recession will ensue.
The problem the BoE has got is that it doesn’t have many tools to use to combat inflation. In fact putting up interest rates is just about the only one and it is a blunt tool at that, as it takes time to work, is inexact in impact and is difficult to manage. They are not in a position to control wage increases or the costs of raw materials, food or clothing, for example. The principle is a simple; put up interest rates to make borrowing more expensive and cash deposits more attractive, which should result in less economic activity and demand for goods and services, so prices fall.
The only problem is that it is not really working in the UK at present; inflation is remaining stubbornly high. Hence the need for the “rate grenade”. The clear risk is that it, along with potentially more increases, will cause the economy not just to slow, but to stall and recession kicks in. Neither high inflation nor recession are palatable, but the BoE has made up its mind which is least preferable.
Have my investments suffered as a result?
UK bond markets, particularly gilts, which are bonds issued by the UK government, have struggled in the face of interest rates rising more rapidly than predicted and also expectations of what will be the peak being revised upwards. This should be no surprise and we may continue to see some weakness until greater clarity emerges. Once that happens, bond markets in the UK should improve, but in the meantime, the rewards on offer look relatively attractive.
In stock markets the dominance of large companies, particularly the giant US technology and communications ones, has remained a feature. In the UK it is similar, with small companies faring worse than the larger ones, even though their businesses might be doing well. Again, as noted last month, it would be usual for this to reverse at some point, possibly quite quickly.
Irrelevant of the weather, it could be a long summer
It feels like there is very little activity from investors at present, whether they be individual or institutional. Given the uncertainty that abounds over the outlook for the global economy and financial markets that have provided healthy returns this year, that is unsurprising. Furthermore, the interest received on cash on deposit has become much more attractive. On top of that there is still geo-political uncertainty with Russia. So, it is understandable that investors will be risk averse for now.
However, it is not all doom and gloom. Inflation and interest rates will peak and economies will strengthen and investors will look through the near-term uncertainty, at some point, to the longer term. For now though, the outlook feels a bit unexciting.
AI
I would be very surprised if you have missed all the excitement and news around artificial intelligence. It is not just our lives that are being impacted, it has become the buzzword in stock markets, with a seemingly never-ending stream of articles, headlines and conference calls dedicated to the subject. New levels of furore were reached with the release of NVIDIA’s corporate results which included a dramatic increase in revenue guidance driven by high demand for AI applications. This caused one of the largest single day moves in US stock market history and resulted in it being the first semiconductor company to cross the $1 trillion size mark.
The share price moves were not limited to NVIDIA, with a rally sparked in the broader technology sector and particularly in anything considered to have direct or indirect exposure to AI. Companies were also quick to highlight their links to the relatively new technology with the number of times ‘AI’ was mentioned in results announcements and follow up calls with analysts, spiking. Unsurprisingly this did nothing to improve the concerns about market breadth as the giant technology companies saw large gains.
There is no doubt this is an emerging investment theme. It may be over cooked in the short term, but the long-term influence and prospects of AI are clear. There will be big winners and big losers, but the headlines are not going away.
The final word
I cannot remember a time when there have been so many large variations in the valuations of different assets and extremes of valuation are being reached.
As mentioned above, the concentration of returns in the US stock market has meant that a very small number of very large companies have driven overall market returns and valuations have polarised at historically wide levels. A similar feature has occurred in the UK, where smaller companies have been spurned by investors and now, arguably, look to be very good value.
Similarly, companies operating in the property sector in the UK and Europe have reached valuation levels only seen in extreme circumstances and the same can be said for investment trusts (or investment companies) that are exposed to a very wide range of underlying asset classes such as music streaming, shipping, energy storage, renewable energy, agriculture and consumer lending.
Whilst these variations are not usual, they do happen. They remind me of taut elastic bands, that will either unwind slowly, snap or something in between. But it should be expected these factors will move back to more normal levels, which will make financial markets easier to navigate.
