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.
Or probably more correctly for what I am about to write about, just; time flies.
Think back to February 2020; COVID-19 was a phrase we were just getting used to and we were not aware of the havoc it was about to cause. Two years later, we are coming out the other side of it, but its impact on the global economy and financial markets is still real, present, substantial and lasting.
You reap what you sow
Since the global financial crisis of 2008, central banks have provided liquidity to the global economy in order to ensure that growth could continue and standards of living could be maintained. COVID brought about the need for that support to be expanded to levels never thought possible and for governments to buy expensive tickets to the party. But, there was no other option.
Two outcomes were predictable; sharp recovery and higher inflation. The problem is that such policy measures on that scale were unprecedented and therefore other outcomes unpredictable. These included just how high inflation might go, how quickly it might get there and what policy response might be required as a result.
Well, we are at that point today. Inflation is rampant and central banks are reacting; the Bank of England raised the base lending rate in December, the US Federal Reserve is reducing its asset purchasing programme, has indicated that interest rates will be going up soon and asset purchasing will reverse in the coming months. The one exception is the European Central Bank, mainly because economic recovery is lagging there.
I will get to the reaction of financial markets in a minute, but it is worth thinking about the medium and long term economic outlook, as asset prices will be driven by that at some point. Forecasts are that global economic growth will be lower this year than it was last year and lower again next year and in all likelihood, lower again the following year. That should be expected after the recovery we have seen. However, inflation itself has a dampening effect on growth and raising interest rates is designed to do so. Therefore, we have an economy which is already slowing, having the brakes applied. Let us not get too worried though, the growth rate is still good; we are not about to enter recession or anywhere near that.
That’s the minute up
Is it any surprise that we are experiencing very big movements in financial markets? No. We are seeing it intraday (at extreme levels), day to day and week to week. It is not just asset classes moving up or down in a homogeneous manner, there are significant differences within asset classes. Not only that, but within industry sectors, technology being a good example, there are huge variations in price movements.
There are many factors that drive financial markets. If you take stock markets as an example, company share prices will be influenced by aspects, including; how well the company itself is doing (profitability), the prospects for the industrial sector it is in, its geographical location, the prevailing economic conditions, the economic outlook, other asset classes and the overall upward or downward direction of stock markets.
At present it is the macro environment that is prevailing; that is the economic environment and the outlook for interest rates in particular. It is driving bond markets and stock markets alike and causing big divergences within them. Investors look to the future and therefore markets take account of (or price in) expected changes. Depending on the day, and this is moving quickly, markets are currently pricing in 4 interest rate increases of 0.25% in the US this year. The first of those is likely to be in March and there is even talk of it being 0.5%. If expectations change to there being 3 moves or 5 or 6, markets will move accordingly. If it is fewer rises, that would suggest that inflation is less of an issue and economic growth is more subdued; bonds should improve, the share prices of companies that are more economically sensitive will possibly do less well and those that are growing strongly do better. Commodity prices, such as oil and gas (subject to demand and supply factors) would probably fall; gener
ally, less risky assets would be the place to be.
If there are 5, 6 or 7 increases, which would mean that economic growth and inflation have become a real problem. That could be an issue for all asset prices as fears would arise of the economic cycle rolling over and possibly an ensuing recession. Opinions vary hugely, and it may prove flippant; but, take your pick, no one really knows. For what it is worth, I think that the first scenario I outlined is more likely. Then of course, there is a third possibility; central banks do not act strongly enough (as they do not want to derail the post COVID economic recovery), inflation surges further and they are forced to act aggressively. That would be worst outcome; the least likely in my view, but many disagree.
What should I be doing then?
So, what does all that mean? Again, in my view; it means having a balanced approach to structuring funds and portfolios is the order of the day. If you have a strong view one way or the other, maybe mitigate the risk of being wrong. Being active is good; that doesn’t mean trading day by day, it is too easy to get whipsawed in fast markets. It means select assets to meet your views and goals, not owning whole markets; why own everything, including the less attractive assets.
End of year report
We are in the midst of the company results reporting season and there is a lot of focus on how the big US companies, whose share prices have been strong in recent years, are faring. There is little doubt they look relatively expensive and for their valuations and share prices to be maintained they need to display ongoing strong growth.
I am writing this the morning after Apple announced their results. In the first quarter of their financial year, their sales increased 11% to $123.9 billion (of which iPhone sales amounted to $71.6 billion). That is strong growth! Importantly, the number was higher than analysts’ forecasts of $119.1 billion on average.
The old stagers Microsoft also announced strong results and saw their share price jump up, whilst newcomer Tesla grew strongly and produced record profits, although the share price slumped as they told investors that they were having trouble with supply chains. $90 billion was wiped off the company’s value. That is a big number as well! It is indicative of the nervousness in markets at present.
There is plenty to keep us focused on the macro and market outlook!
The last word
Geo-politics is firmly back on the agenda with the Russia / Ukraine issue very much live. I get asked what we are doing about it within the funds. To be honest, there is a limit to what we can do, other than ensure that we do not have exposure to any assets that may suffer as a result of whatever it is that may happen. That is possible to do in a specific way, but any incursion or invasion by Russia is likely to push up energy prices and that has a more wide ranging impact, which probably can’t be avoided. For now, like the rest of the world, we maintain a watching brief.