Investment Director of Premier Miton’s Multi-Manager Funds
For information purposes only. The 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.
Keeping their head above water?
No one needs me to tell them what a tough period it has been for investors over the last 15 months or so with equity markets struggling to keep their head above water while bonds (and particularly those that are longer dated) saw their sharpest fall in decades last year.
While there are several reasons given for the decline in so many risk assets, to me, the end of cheap money sits way ahead of anything else. If the risk-free rate increases, then so asset prices must adjust accordingly. However, it is not just the fact that interest rates have increased, because at the beginning of 2022 many (including us) expected rates to increase. Quite simply, it has been the level of increases and the speed of central bank action that has spooked the markets.
The reason that the cost of money has increased so rapidly is of course down to the very high levels of inflation that so many countries have endured over the last couple of years. Many felt that a combination of ageing populations, high levels of debt (government, corporate and consumer) and low productivity would result in low inflation (and interest rates) for the foreseeable future. However, this has turned out to be very wide of the mark with a combination of over a decade of ultra loose monetary policy (including money printing on an unprecedented scale), followed by huge government giveaways during the pandemic, resulting in the eyewatering price rises that we have seen over the last year or so.
Where now for the global economy and markets?
On the economic front the debate remains whether there will be a global recession or not. For us, this seems unlikely with China’s reopening offsetting a slowdown elsewhere. That said, we have now seen, with the turbulence in the banking sector, that the rapid rise in interest rates has started to impact the broader economy and a recession in the US and elsewhere is a distinct possibility.
It’s certainly a tricky situation for investors to navigate. On the positive side, inflation is coming down with recent US CPI at a 2 year low and in the UK, last month’s rise in inflation will soon be reversed with the rate of price rises likely to decline sharply over the rest of this year. However, core inflation is proving sticky and labour markets remain extremely tight and against this backdrop, a return to 2% inflation anytime soon seems wide of the mark. That said we believe that we are approaching the end of the current rate hiking cycle but would have thought that inflation will have to fall much further before central banks consider loosening monetary policy.
As far as the markets are concerned, some commentators have argued that rate cuts will be good for risk assets. Certainly, investors in developed market government bonds would benefit but for equities it doesn’t seem so clear cut. Yes, companies like cheaper money but irrespective of the direction of interest rates, banks are likely to be pickier who they lend to and on what terms following the problems (something of an understatement!) with Silicon Valley Bank and Credit Suisse. In addition, any future rate cuts may be on the back of economies weakening more than anticipated and this will almost certainly have a detrimental impact on corporate profits and therefore share prices.
The storm clouds could be clearing
In summary, we believe that the next few months will be challenging and are not looking to increase risk in our multi-asset (multi-manager) portfolios at the current time. However, with asset prices declining for well over a year, we believe the medium-term outlook for equities and especially bonds is far better than it was at the start of 2022.
For the time being we are happy to maintain our higher allocation in bonds (both fixed debt and floating rate) while in equities, we continue to focus on those markets that offer the best value. In our opinion, the UK is at the top of the list with domestic stocks remaining, unloved and under owned and therefore, reasonably cheap. This contrasts with the US stock market, where valuations remain high and therefore share prices are potentially more vulnerable to an economic slowdown.