INVESTMENT LINE: OUR CURRENT THINKING ON MARKETS - MARCH 2022

Looking at equity markets, you could almost be forgiven for thinking that the conflict in Ukraine was over and the concerns over inflation and monetary policy were no longer with us. Even European indices have managed to rally and are now above the level they were at before the invasion began in late February. Some of this might be a reflection of the fact that the markets expect a resolution, not least because of the stalled “progress” which Russia is facing. A sufficient period of time has now elapsed and markets can digest the effects of sanctions, so although the effects are far reaching, the lack of an immediate European import ban on Russian oil has brought some relief. Investors are also seemingly relaxed about the path of central bank policy, and even the more hawkish remarks from the Federal Reserve over the past week have been received without dramatic moves in equities, though bonds have seen a larger sell-off. Some relief is perhaps being felt that central banks are going to address an inflation problem which looks anything other than transient. A very large amount of positive news seems to be priced into markets at these levels, which of course leaves the scope for disappointment.

Firstly, on monetary policy, are rates going to be able to move up to a level which arrests inflation without imperilling the economy? Recession is now a real risk on a one-year time frame and the yield curve is suggesting this as it approaches inversion. Regarding the conflict we are all longing for a deal, but progress seems less than assured and a desperate Putin could yet take the conflict onto another level. Then of course we have the complications created by the stance of China towards the war and the potential consequences this could have for relations between that country and the West. The benign period of globalisation and its soothing effects on inflationary pressure and economic growth are rapidly fading. So many unknowns, yet we have markets (investors of course) which/who seem to be comfortable all of a sudden. We are not so sure. Maintaining our cautious approach risks equities racing ahead on an extended relief rally, but it seems the sensible course of action.

Stagflation has now become a genuine concern for many. It has moved from a minority and even eccentric view to a perfectly plausible scenario. Determining what performs well in such a setting is not an easy task but history does provide some clues. Treasuries are in demand in times of market stress and diminished growth prospects but are unattractive in the face of high inflation. Equities are something of a mixed bunch. Growth names might be relatively attractive if recessionary conditions prevail but are vulnerable to higher rates. Conversely, value could be attractive due to higher rates, but cyclical names might find the economic conditions a headwind. What do appear to do well are real assets such as property REITs and infrastructure which are well represented in portfolios. Commodities are another area we have looked at closely of late for inflation protection. The case for investing in energy is not dependent on the oil price staying at these elevated levels – free cash flow yields enjoyed by the oil companies are compelling even with oil significantly lower than where it currently is. There are risks around political pressures on energy companies but for adventurous investors, non-renewable energy names look like an attractive proposition, and we are adding where appropriate. Recently, gold has proved itself invaluable in offering “crisis alpha” for investors – if we really do get a stagflationary environment there is every reason to think this could be as real a crisis for investors as both Covid-19 and the Ukraine conflict have been.e as being an unwise portfolio choice, especially in times of higher inflation, in times of volatility it can be invaluable. If your bond and equity holdings fall, the impact of inflation affects you there too, with real returns even lower than any headline losses. Cash also has what is termed very high optionality. We are facing very difficult markets where tactical changes are likely to become more important than they have been in recent years and avoiding potentially significant losses and keeping dry powder for ensuing opportunities seems like a sensible course of action. We are trimming equity positions in lower risk portfolios, with an eye on reinvestment later in the year, when some of the risks have hopefully dissipated.

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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