Inflation concerns and rate expectations drive a volatile start to the year
Price volatility in investment markets, already concerned about inflation, rising interest rates and tensions in Eastern Europe, was accentuated by a technical position in the derivatives market. Developed economy equity markets ended the month 5% lower, though emerging markets fared better, losing only 1%. The exception to this sell-off was the main UK index, which gained 1% due to its high weighting in energy, mining and bank stocks, all beneficiaries of higher interest rates. Fixed interest bonds lost between 1% and 3%, with UK gilts suffering the most.
Global growth slows on Omicron caution, but labour markets stay strong
The global economy expanded for a nineteenth straight month in January, according to the JPMorgan Global PMI, although the pace of expansion slowed to an 18-month low. The slower rate of growth was expected, given the restraint shown by consumers in the face of the Omicron virus. Employment data, however, continued to surprise to the upside: the US saw a further 467,000 join the workforce in January, making over 900,000 jobs added over the Christmas and New Year period. In the UK, the unemployment rate dropped to 4.1% and the number of job vacancies rose to a record high of 1,247,000.
Inflation remained the focus of attention, with central bankers accepting that the word "transitory" needed redefining. The United States topped the charts in the developed world, with prices rising by 7%, the highest rate since 1982. Headline inflation in the UK hit 5.4%, with the euro area not far behind at 5.1%. One of the main drivers was the continued rise in energy prices, and that was before the 17% rise in oil prices during January alone.
The Bank of England raises rates as the Fed lays the groundwork
The New Year marked a tangible move towards central bank tightening. In early February the Bank of England raised rates by 0.25% to 0.5%. This was as expected, but what shocked the markets was the revelation that four of the nine voting members had voted for a 0.5% rise, and that it was only the Governor's casting vote that had prevented it.
The US Federal Reserve laid the groundwork for raising rates at its March meeting, though opinion remains much divided over whether this would amount to a 0.25% or 0.5% rise. Even the European Central Bank contributed with talk of higher rates during the year, though a poor attempt was subsequently made to water down these remarks.
Turkey's President Erdogan produced a novel approach to dealing with the country's 36% rise in prices: he sacked his Statistics Chief, who had the last laugh as subsequent data revealed annual inflation of 48%.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
Omicron's drag on growth should prove temporary
We expect that the dampening effects of the Omicron pandemic on growth will prove to be temporary and that, as infection rates fall, pent-up consumer demand and receding supply bottlenecks will re-ignite global growth. We can be less certain of where that drives inflation, but we remain wary that markets are still pricing in a fairly quick return to normal.
Currently, bond yields and central bank monetary policy are driving equity markets, with the rotation from growth into value shares much in evidence. Year to date, UK bonds are showing losses of around 5%, yet the 10-year gilt yield is still only 1.4%, offering a real return adjusted for inflation of minus 4%. The yield on the German 10-year bond is offering a positive return before inflation for the first time since May 2019.
Central bank talk is getting tougher, with members in the US and UK, and some in Europe, now alluding to a series of rate hikes this year as well as a desire to bring forward quantitative tightening. The shape of the yield curve and forward breakeven rates still reflect market expectations for a short sharp shock with higher rates, followed by a return to targeted inflation levels with slower growth, or possibly even recession, within a couple of years.
Cash and bond yields are a long way below inflation, diminishing the real value of savings.
With high energy prices and rising taxes in the UK, there has to be a risk of policy error, but the perceived peak in interest rates is still seen at somewhere below 3%, which is below the current level of inflation. Little allowance has been made for a period of continued growth and the possibility of tight labour markets driving wages, and therefore prices, higher. Interest rates are starting to rise, but cash and bond yields are a long way below inflation. Those with cash savings will see the real value of their money diminish unless they can find investments offering higher returns. In our view, a diversified portfolio, favouring equities over bonds, remains the best way of producing inflation-beating returns over the long term.
Our exposure to value-orientated funds helped portfolios outperform their benchmarks year to date, and we continue to favour equities over bonds in a portfolio diversified across a wide range of assets.
Underweight fixed interest
Our portfolios have benefited from a reduced weighting in fixed interest bonds more sensitive to rising interest rates. We are likely to remain underweight for the foreseeable future, as yields still offer little reward for the potential risk of capital loss. In portfolios that require bond exposure, we favour funds linked to inflation or rising interest rates, with limited exposure to rising yields.
Equities over bonds
A diversified portfolio, favouring equities over bonds, remains in our view the best way of producing inflation-beating returns over the long term. The rotation from growth into value shares continues to benefit our positioning.
Alternative assets for diversification
Our portfolios diversify risk by investing in a wide range of assets using actively managed funds with sound investment processes. Examples of these alternative assets include funds invested in gold and silver, infrastructure, agriculture and absolute return strategies.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
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