The rock in the pond

David Jane

Premier Miton Macro Thematic Multi-Asset Team

Back in the early years post global financial crisis (GFC) we used to refer to the market patterns as a ‘rock in the pond effect’. The GFC and the subsequent introduction of Quantitative Easing (QE) had a huge impact. They gave rise to reverberations that repeated with reducing amplitude over the subsequent years. That original crisis was followed by a series of mini crises and further bouts of QE. These ultimately faded, as arguably did the impact of the QE. The waves gradually reduced over time.

The covid lockdowns and the massive monetary and fiscal stimulus that went with them are likely have an even larger impact. This time the effect was not just on the financial markets but to a much greater degree on the real economy. Supply chains around the world were disrupted and demand patterns distorted. An initial massive contraction of output and demand, combined with massive easing was followed by a similarly large rebound in demand and the attempt to tighten rates. In every way this was a much greater shock.

Having seen the first wave of contraction and rebound, we are now entering a period where the economy may again be contracting as the rebound bump fades. Inflation may soon peak as companies find they have overstocked into the rebound period. Commodity prices are falling in most areas, reflecting contracting demand. Policy may move from tightening to easing sooner than expected. We could quickly switch from a period where the story is all about inflation and tightening to one where it is about shrinking economies, disinflation and easing.

We take the view that for various reasons discussed before, there will be an extended period of structurally higher inflation, but it doesn’t mean that there won’t be cycles of increasing and reducing inflation and growth throughout. We are now potentially at the end of the first phase. Economic growth indicators are suggesting a slowdown if not outright contraction already, so soon after the recovery. This feels something like the boom bust cycles of the 70’s.

The chart below shows US quarter on quarter annualised GDP growth, which had been pretty stable around 2-3% for some time since the GFC, we think it will oscillate for some time going forward.

US quarter on quarter annualised GDP growth

Source: Bloomberg 30.09.2007 – 31.03.2022

As demand contracts, reported inflation will likely again decline, although perhaps not to the levels seen in the pre-Covid era. The rapidity of the current cycle and the amplitude of the swings makes portfolio positioning much harder. We are likely to swing back and forth in this way for some years to come. Arguably, a rise in the equity risk premium is merited as a consequence. Equity valuations are typically lower during periods of higher inflation. While positioning in the longer term suggest a bias to real assets for inflation protection, protection against equity down markets and economic contraction is also needed at times.

We believe that very active management will be required in this era, static portfolios may get whipsawed, something which clients do not like. Alongside a structural bias to real assets, value equities, gold, other commodities and property will be the correct structure over the long term. However, this may be vulnerable in the periods of falling growth and inflation. As the economic outlook has deteriorated we have significantly rebalanced away from commodity cyclicals in favour of utilities and staples and reduced our Exchange traded commodity (ETC) exposure.

The greater challenge is what to do with bond portfolios in this environment. While we take the view that fixed income in general will be a poor investment during a longer-term period of higher inflation, there may well be periods where government bonds experience significant rallies in their downtrends. Hence, we have recently increased government bond exposure on the view that interest rates may already be close to their peak in this cycle.

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Risks

The value of stock market investments will fluctuate, and investors may not get back the original amount invested.

The performance information presented in this document relates to the past. Past performance is not a reliable indicator of future returns.

There are times when the issuer of a security (for example, a company that has issued a bond) is unable to make income payments or repay its debt. When this happens it can result in losses for the fund.

Commodity prices can fall and rise sharply depending on supply and demand, the economic background and financial market conditions. Exposure will never be direct to any commodity.

Higher inflation can lead to some investments falling in value, particularly those with a fixed level of interest, for example government bonds and corporate bonds.

Forecasts are not reliable indicators of future returns.

IMPORTANT INFORMATION:

For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within this document.

Whilst every effort has been made to ensure the accuracy of the information contained within this document, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice. Reference to any particular stock does not constitute a recommendation to buy or sell the stock.

Persons who do not have professional experience in matters relating to investments should not rely on the content of this document.

For your protection, calls may be monitored and recorded for training and quality assurance purposes.

Issued by Premier Miton Investors. Premier Portfolio Managers Limited is registered in England no. 01235867. Premier Fund Managers Limited is registered in England no. 02274227. Both companies are authorised and regulated by the Financial Conduct Authority and are members of the ‘Premier Miton Investors’ marketing group and subsidiaries of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

007213/2807022

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This section of the website and the content it contains is for retail clients only and by persons who are resident in the United Kingdom [who are not US persons]. Professional advisers should refer to the Professional Advisers site.

The content of the pages of this website is for your general information only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

You acknowledge that such information may contain inaccuracies or errors and we expressly exclude liability for any such inaccuracies or errors to the fullest extent permitted by law. Your use of any information or materials is entirely at your own risk, for which we shall not be liable.

The information contained on this website does not constitute an offer or solicitation to sell or purchase shares in the funds or portfolios or to provide you with other products or services. Any application or investment must only be made on the basis of the relevant documentation of the investment, such as, for example, terms and conditions. The information on this website does not constitute any investment, tax, legal or other advice. Persons who do not have professional experience in matters relating to investments should always consult with an independent financial adviser before making an investment decision. Any opinion expressed on individual funds, services or products represent the views of the individual at the time of preparation and should not be interpreted as a personal recommendation to buy or sell or otherwise trade all or any of the investments that may be referred to.

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This section of the website and the content it contains is for professional financial advisers only and should not be relied upon, or circulated to, retail clients. Retail clients should refer to the Private Investor's site.

The content of the pages of this website is for your general information and use only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

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The information contained on this website does not constitute an offer or solicitation to sell shares in the funds or portfolio or to provide you with other products or services. Any application or investment must only be made on the basis of the relevant documentation of the investment, such as, for example, terms and conditions. The information on this website does not constitute any investment, tax, legal or other advice. Persons who do not have professional experience in matters relating to investments should always consult with an independent financial adviser before making an investment decision. Any opinion expressed on individual funds, services or products, represent the views of the individual at the time of preparation and should not be interpreted as a personal recommendation to buy or sell or otherwise trade all or any of the investments that may be referred to.

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