INVESTMENT LINE: OUR CURRENT THINKING ON MARKETS - JUNE 2022

After a very modest rally, most major markets have continued their downwards trajectory and some of the moves have been pretty dramatic. Continued bad news on inflation has met with what looks like a firmer resolve from the Federal Reserve and other central banks, and investors have moved quickly seeing/anticipating higher interest rates. 

Commentators have stressed how this is very different from the 1970s, despite the depressing backdrop of high inflation and low growth. True, there are significant differences between this period and that one, but comparisons with the 1970s look less ridiculous when one sees the newsflow around strikes in the UK (and Abba in the news). Unions may not be as powerful as they were here or across the globe, but they are likely to find renewed strength in response to persistently high inflation. The possibility of a wage price spiral both here and elsewhere is not trivial and the hope is that inflation eases to around the 4-5% level by year end. The problem though, is that this level is still higher than markets are expecting in their valuation models for most assets, so some further “readjustment” might have to occur.

Valuation multiples have already fallen but earnings estimates in the US – the other half of the price/earnings ratio - have barely moved. This has to be something of a concern considering that the odds of a recession look to be increasing almost by the day. Maybe there is a chance that the Federal Reserve can engineer a soft landing but that looks like an incredibly difficult feat to pull off and hopes are fading. Certainly, some of the recent US consumer sentiment and housing data is pretty worrisome. Although unpleasant, the most obvious question to ask is just how bad this could get. Of course, it is almost impossible to answer this question. We are dealing with a complex system and consequences can be felt in areas remote from their starting point and to degrees not initially foreseen. If we get a steep fall in earnings expectations, there is a risk we could move meaningfully lower, and this possibility makes caution our continued default position.

This approach applies to the fixed income space as well, as we do not really want much exposure to credit at a time when the global economy is faltering and recessions look inevitable in the UK and Europe (and highly likely in the US too). Sovereign debt might be selling off, but US Treasuries are likely to prove their worth in a recession and continue to be a feature of portfolios. The air is coming out of several areas, exemplified best perhaps by the collapse in many crypto currency prices and the structural problems in that marketplace.

The bear market will produce some wonderful opportunities for investors, but it still feels early to increase risk allocations with so much uncertainty around. When the time comes to act, we have plenty of dry powder and assets which will have preserved their value in order to allow us to take advantage of lower prices. We have already carried out some de-risking and holding these positions looks justified given market falls and the various likely outcomes. Investor sentiment is pretty much rock bottom already, but things will improve at some point- for now, it is a case of maintaining patience and discipline.

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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