GLOBAL MARKETS
We regularly stress the importance of remaining calm and not making dramatic changes to portfolios in response to market events. There are times, however, when the backdrop becomes so troubled and uncertain that substantial changes are justified. This is one of those times. The threats facing markets – the Russia-Ukraine conflict, China’s economic difficulties, slowing growth and stubbornly high inflation – are forming an intimidating cocktail of risks which are undermining markets, and investors are nervous. The Federal Reserve and other central banks have realised that inflation is going to need a much tougher response than thought last year and this realisation has not been lost on investors (and therefore markets) either, and many equity markets are coming under sustained pressure. Those areas which benefited most from the cheap money and liquidity which flooded asset markets since the financial crisis have been battered most in the current storm and this looks likely to continue for a while. Commentators are now starting to discuss when the recession induced by high prices and the response to them will occur rather than if there will be one and this is a significant change in mentality. The US would appear to be much further away from a recession than the UK or Europe, but the very strength of the US economy means that an even stronger monetary policy response will be needed to quell inflation through weaker demand, which might mean more pain for markets. There really is no magic way out here – the combination of weakening growth and high inflation is a toxic one and pain is inevitable. The air is coming out of asset bubbles and let’s be honest, there is a significant amount of air which has been accumulated over the last decade. The hope for now is that credit and housing markets will not be too dramatically affected – economies can generally survive significant falls in equities but struggle once problems get into the banking system through these channels then we potentially enter financial crisis territory. We are not in this position at the moment, but the prevailing conditions do justify the removal of some more risk from portfolios. The rising rate environment is unlikely to be friendly to many asset classes though it is equity positions we are trimming at this time. Within the fixed income space, concerns over economic vulnerability and the strong dollar have led us to remove emerging market debt exposures. Protecting clients in these testing times remains our absolute priority, and yes, we are positive on a few areas, just conscious that it is harder to see some of the returns we have perhaps become more used to in recent years in the coming months. We remain broadly invested and well diversified, both essential.
UK EQUITIES
Dear old Blighty has her fair share of challenges at the present time. The cost-of-living crisis is here in a meaningful way and the Bank of England is telling us that rates are going to have to rise to address inflation but that the economy will probably not be strong enough to take it and the measures might not work anyway! So, we look set for a recession, that is, if we are not already in one. The central bank’s message has been taken by investors as an indication that the UK will not match the pace of policy tightening elsewhere (meaning the US) and sterling has taken the brunt of this, weakening materially against the US dollar. Our currency has been vulnerable since the Brexit vote (arguably before that as well given our budget and trade deficits) and continued weakness is likely to worsen further the inflationary pressures impacting the economy. Potential problems with the EU over the Northern Ireland Protocol are not going to prove helpful for sentiment either and it does feel as if the UK is in a tough spot (though clearly not alone in this regard). Of course, the problems make UK large cap an interesting place to be given that the overseas earnings of the multinationals benefit from the weak pound, but other areas more dependent on the domestic economy may struggle. There will of course come a time to add to these areas but it does not feel as if this is it.
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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