Investment Line is a regular investment bulletin produced by Mattioli Woods plc. The communication provides an update on funds, highlights some of the areas we are focusing on, and shares our thoughts on the issues of the day.
We have been warning for some time about the complacency in markets and our concerns materialised toward the end of November. The emergence of a new Covid-19 strain in the form of Omicron has created renewed uncertainties for markets and headaches for investors. At this point it looks as if the variant is weaker in terms of the symptoms it causes, but the much greater transmissibility means that public health care systems could come under strain in the coming weeks or months which inevitably means new restrictions, if not full lockdowns. The UK has tightened its policy in this regard and a widespread range of travel restrictions have been introduced across the globe. For the optimists, the (apparent) diminishing of symptoms means we could be moving towards the end game with Covid-19 where it becomes endemic in the population and can be dealt with through a standard vaccination programme. For the pessimists, the uncertainty means we could face more extreme measures which will act as a drag on the economy and generate additional supply side and hence inflationary pressures. Markets initially reacted with the shock one would expect but the suggestion that it will be “milder” than the Delta variant has meant a swift recovery for many equity markets. So, we are sort of back to where we were but with additional uncertainties which seems, well, complacent. Even if economic activity is not significantly impacted for long, markets have the issue of inflation to wrestle with. The Federal Reserve has abandoned its use of the term “transitory” and three US rate rises now look likely in 2022, while the Bank of England has already embarked on tightening with a modest increase in base rate yesterday. This could expose vulnerabilities in both bonds and equities, though the impact of the expected changes has mostly been on shorter dated bonds so far. The perils of fixed income have led many to suggest that “there is no alternative to equities”; the ubiquity of this phrase is reason to pause for thought. Adding risk at these levels may seem tempting as investors fear missing out on a momentum trade in equities, but it also looks dangerous given the uncertain backdrop and rich valuations.
Those looking for investment opportunities in a world of high valuations might be able to make a plausible case for emerging markets. In equities, valuation discounts to developed peers (especially the US) are high by historical standards and the absolute valuations look reasonable. When one looks at debt, some of the yields on offer can seem to come from a different universe compared to those of the developed market bonds. This superficial take hides a multitude of problems faced by the emerging markets complex, however. Though itself a homogenous opportunity set, the problems faced are common to many of the constituents. Vaccine rates are significantly behind those in developed countries and the increased fiscal spend undertaken by most governments has not translated into meaningful upticks in growth rates for many. Vulnerability to Omicron and a slowdown in global trade aside, many also face headwinds from the tightening of monetary policy by the Federal Reserve. Normally this sees capital flow away from emerging markets and worsens debt positions for those with dollar denominated borrowings. Some EM countries also face further issues from a slowing China with commodity producers especially dependent on demand from the country. For sure there are some opportunities here as elsewhere, but at the moment the message is very much buyer beware!
Investment Line is written and edited by members of the Mattioli Woods Group investment committee and is for information purposes. It is not intended to be an invitation to buy, or act upon the comments made, and all/any investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances. The value of investments and the income from them can go down as well as up, and you may not get back the amount invested. Past performance is not a guide to future returns.
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