Putin’s war in Ukraine has increased the volatility of global markets since February of this year. However appalling the human cost of his actions, the key factors affecting investments continue to be those discussed in last month’s market update, namely inflation and interest rate rises (discussed later).
At the time of writing, global markets, with the noticeable exception of the UK, are negative for the year, and many once-popular stock market areas continue to struggle following a tougher start to 2022. We have seen some of the former ‘working from home’ (WFH) stocks get decimated as most societies, ex-China, are now almost back to pre-pandemic levels of social activity. As an example, Peloton has lost more than 80% of its value since its price peaked in December 2020. However, investors are not without hope and portfolios which hold a diverse range of assets are protected from some of the worst of these market movements.
Inflation & Interest Rates
In our opinion, the most impactful factor influencing markets is unanchored global inflation. Perhaps, more important is the acceptance by central banks that this inflation is not transitory and has become entrenched primarily due to their deluded group thinking that the causes were solely supply-chain based. The outcome of persistent inflation means we can expect to see central banks continuing to raise interest rates to curb price increases for many months to come.
The difficulties for the ECB look particularly insidious, as the Fed effectively gave Lagarde and co the transitory theory justification to take no action to get ahead of the inflationary spiral. Now they have the considerable complications of Putin’s war, but inflation is already at 7.5% and expected to climb further. They really have a genuinely unenviable task to develop a plan to address inflation and one that meets the needs of all its member states.
This is a very different investment environment from the last decade, which was characterised by low inflation levels and extremely low-interest rates. As a result, we have seen assets, that had previously performed poorly, go through a period of outperformance returns and vice-versa for those that had once been the best performers.
There is, of course, more nuance to this. Still, we have seen the share price of technology and digital companies go through a period of difficulty, and real (tangible) assets perform well on a relative basis. This situation is evident in our everyday lives through the rising price of oil/gas, metals from nickel to uranium and even foodstuffs. Other real assets, including property, infrastructure, and precious metals, have also been powering ahead. The abrupt change in the sector winners and losers has been reflected across worldwide stock markets almost irrespective of geography. However, it is worth noting that the UK has a natural bias toward oil/gas and has finally performed very well compared to developed market peers.
Chinese Equities
One area that has struggled relative to the rest of the world has been Chinese equities. In the first quarter of last year, the Chinese government aggressively added regulations for its largest technology firms, imposing restrictions on gaming to tackle addiction and destroying for-profit education services almost overnight. These self-imposed regulations, combined with the situation facing property giant Evergrande and continuing COVID-19 lockdowns, have led to significant investor uncertainty. As a result, Chinese equities have lost over half of their value from February 2021 to mid-March 2022.
However, the medium-term outlook has somewhat improved, and unlike developed market equities, the Chinese government have expressed the desire to be more supportive of its markets. Of course, investing in Chinese equities in isolation does come with a significant degree of risk, but the combination of lower valuations and more supportive government policy could be a very potent combination for investment managers with the ability and expertise to invest in the area.
Fixed Income
It is also worth touching on the performance of bonds.
These historically have tended to be used as the defensive portion of an investor’s portfolio. Unfortunately, many bonds are susceptible to rises in interest rates, with the many bonds falling alongside equities so far in 2022. One of the best defences for fixed income assets against rises in interest rates caused by inflation is to hold shorter-duration assets or cash, both of which (due to their short-term nature) are less impacted by rising rates. The immediate issue is that they cannot produce real positive returns with inflation at these levels, but then we would caution investors not to take a straight read across to say equities look attractive.
In our opinion, it is time for reduced bond risk whilst being selective on the geographical allocation of equities.
Alternatives
Finally, given the headwinds facing both bonds and equities, we continue to research funds in the alternative space, especially some of the absolute return funds.
Governments and central banks continue to battle the forces of inflation and supply chain issues in a world that is deglobalizing, also known as ‘slowbalisation’. We need to remain vigilant to the new risks and opportunities across the investable spectrum to combat this, as neither inflation nor the bottlenecks are going away anytime soon. In fact, we see the Fed finally accepting that inflation is not transitory as bringing to an end the protracted era of lower (interest rates) for longer.
We recently wrote a piece highlighting the risks of investing using the rear-view mirror, and with each passing data point, these risks become heightened.
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