Neil Birrell
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.
At a barbeque I attended over the August bank holiday weekend, the topics of conversation were not that varied and not very holiday like or light hearted. Although the group was not a diverse one and, I would guess, relatively financially secure by most comparisons, I suspect the topics would have been similar in many gatherings over the weekend.
You will be able to guess the themes; inflation, energy prices, interest rates (or mortgage payments), collectively known as the “cost of living crisis”. Throw in debate on who the next Prime Minister will be, government indebtedness, when could grown up children afford to move out of the family home, the war in Ukraine and Chinese intentions towards Taiwan and you get a long list of concerns holding attention in the UK at present. The group wanted answers! I think it’s fair to say, that other than possibly the political ones, the answers are wanted in most developed countries.
I guess, therefore, the next question that we should be asking is; can it get any worse?
The numbers are heading higher
Some of the forecasts for inflation in the UK are quite startling. If Citigroup’s prediction of it peaking at 18.8% is reached, or, worse, Goldman Sachs suggestion that it could be over 20%, it is possible that the Bank of England will have put interest rates up to 7%, or maybe even higher, to combat the problem (source: Reuters).
In the US, at the Jackson Hole Economic Symposium, the central bank continued to talk tough over its approach to tackling inflation. That means two things; interest rates will be heading higher and the reversal of other loose monetary policies (Quantitative Easing) employed through the pandemic will be reversed. The economy in the US remains robust relative to other countries and it may be able to handle rate increases better.
The Eurozone is more like the UK, and not in such good shape. Inflation is surging there as well and the only debate is how much the European Central Bank will put rates up by at its next meeting.
Similar factors are at play around the world.
Does that mean financial markets will head lower?
Not necessarily.
In aggregate, investors look to the future and make decisions based on what is likely to happen rather than what has happened. It is more a case of how far ahead they are willing to look. Just at the moment, though, you need to look quite a long way forwards to see light at the end of the rather dark tunnel we are in.
What fund managers do about it
I don’t know, but I would imagine that the crew at the barbeque have investments over and above their pensions and houses; they will use fund managers one way or another.
In conversation with fund managers in the specialist investment teams, across different asset classes at Premier Miton, it is difficult to find anyone who is positive in the short term. In fact, it would be relatively easy for me to come up with reasons not to own any of the main asset classes today.
Unsurprisingly, the fixed income team, who focus on government and corporate bonds, which typically suffer in periods like this are not talking of higher bond prices. So as a result, they are running the funds with lower risk profiles than would normally be the case. That means bonds that mature in the shorter term and bonds that are higher quality. All sensible stuff. They are also able to mitigate risk through the use of derivatives, this is called hedging; it means that an investment is made that does well if another investment, or group of investments, falls in price. These hedges can be quickly removed if required.
The equity fund managers are, very importantly, sticking to their long term investment approaches. We invest the funds for the long term, 5 years or more, and seek to look through short term market moves; but they do provide opportunity and we are active managers. Many of the fund managers have reduced some of the weightings to companies that are more sensitive to weakening economic conditions and rising inflation and interest rates; again, all sensible stuff.
In the funds that invest across different asset classes, we have adopted similar approaches, in essence; strong risk management.
Answers for the barbeque crew
The economic outlook is not good. Financial markets have clear risks at present. Your fund managers can mitigate those risks, but they are real. The longer term outlook is better, asset prices will rise, but it could be from lower levels than today’s.
Away from the economics; some good news
The prices of most asset classes have been driven by the economic data and outlook, (often called macro factors) including; bonds, equities, real estate, even Bitcoin. Commodity prices such as oil, gas, metals and agriculture have been more subject to demand and supply; as these are more specific to each commodity, they are more micro factors, although it’s clear that the macro is at play here as well.
One micro factor that has been more encouraging than was expected has been company profitability. In the US, companies report their profits and provide guidance on the outlook every 3 months, in what is known as the “corporate earnings season”. It is similar in other regions, although not all report quarterly and the US is a focus because of all the large, well-known companies there.
Encouragingly, in aggregate, companies (in the US and elsewhere) reported better profits than the worst expectations, including mine, for the second quarter of the year. More encouragingly, their comments for the rest of the year were not as bad as expected. Of course, it’s possible they are wrong, but it is not in their interests to mislead the markets.
But, macro influences have overridden the micro and share prices are being driven by the more negative influences.
The last word (or what will the barbeque crew be talking about this time next year?)
Since the Brexit referendum, it seems that the topics of conversation have been; well, Brexit, UK politics, US politics, COVID, Ukraine and the cost of living crisis. None of these are much fun to discuss.
They will all wax and wane to one degree or another. But we should not forget, that we will reach a point where politics is low on the agenda, COVID is further in retreat, Brexit is a memory and inflation and interest rates are falling. In fact, the last two of those should come about next year, COVID is much less impactful today and I, for one, am trying very hard not to use the B word.
So maybe it can be the darkest before dawn, no pun intended should there be power cuts this winter.