Inflation dominates, but equities find their footing
The past few weeks were dominated by concerns over the ongoing rise of inflation and the consequent rise in interest rates. Despite this, stock markets rallied from their mid-month low to close March in positive territory. In sterling terms, shares in the United States and Asia led the way with gains of 4-5%, while the United Kingdom, Europe and Japan reflected gains of between 1% and 2%. Since the Russian invasion of Ukraine, developed markets have risen some 4-6%, although UK government bonds have fallen sharply, with losses of 5% and over 8% in the index-linked variety.
Economic growth continues as services take the lead
Economic releases, reporting on the world before Russia-related sanctions took full effect, confirmed further growth, but with a shift in emphasis. The manufacturing sector continued to suffer from a shortage of labour and supplies, while the services sector received a boost from an easing of lockdown restrictions. Unemployment rates in the US and UK fell further, and unfilled positions reached record highs. There was, however, a widespread fall in confidence, attributable to a combination of the ongoing atrocities in Ukraine and the rising cost of living.
The cost of living continued to rise at an alarming rate. Inflation in the United States, Europe and the United Kingdom came in higher than expected at 8.5%, 7.5% and 7% respectively. Optimists pointed out that some one-off factors such as used car prices were beginning to roll over, and that much of the current rise was down to base effects from historically lower prices. In the UK, however, the average 54% rise in energy bills that came into effect on 1 April is forecast to add 1.6 percentage points to the next reading, bringing headline inflation close to 9%.
The Fed signals six further rate rises as the Bank of England urges caution
In the United States, the 0.25% rise in rates was small and as expected, but the warning to expect a further six increases during the year took traders by surprise. Federal Reserve Chair Powell cautioned that rates could rise by 0.5% on more than one occasion and that the Fed would move to more restrictive levels if required to restore price stability.
The Bank of England raised rates by a more modest 0.25% but suggested that further tightening would continue at a slower pace, owing to uncertainties surrounding the economic outlook. Meanwhile, the European Central Bank maintained rates at current levels and confirmed plans to end its bond purchases in the third quarter of 2022.
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
The yield curve inverts, raising the spectre of recession
A major talking point over the past month has been the US yield curve inversion. The yield on shorter-dated bonds, those maturing in two or five years, rose by more than the yield on longer-dated bonds maturing in ten years, to the point that a ten-year bond was briefly yielding less than one maturing five years earlier. This is significant because it has a consistent record in signalling a future recession.
The argument is that shorter yields were anticipating the series of interest rate rises expected from the Federal Reserve, while longer yields reflected the expectation of a policy error: the Fed tightening too far and tipping the economy into recession in 2023 or 2024. The counter-argument is that after years of being manipulated by central bank buying, bond yields were starting from the wrong level and could no longer be trusted as a reliable market signal.
Much of the world remains in rude health, with strong consumer demand and corporate earnings being declared above forecast. Even after the anticipated rises, interest rates will still be close to historically low levels. On the other hand, the rising cost of living will not only challenge central bankers but will start to weigh on household budgets. Various degrees of lockdown in China have seen output and demand in the world's second largest economy weaken, and geopolitical tensions stand arguably at their highest point in decades.
Cash and bond returns remain well below inflation, diminishing the real value of savings.
In the near term, we feel that investors may be a touch complacent and that further shocks to market confidence will emerge from time to time. The returns on cash and bonds remain well below the current levels of inflation, diminishing the real value of savings. We remain of the view that a diversified portfolio, favouring equities over bonds, remains the best way of producing inflation-beating returns over the long term.
The recent rally moved prices away from the entry points we had identified, but we do not feel this is a market to chase. We believe opportunities will present themselves again, and if the rally continues it may be worth taking some profits on existing holdings.
Underweight fixed interest
We are likely to remain underweight fixed interest 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
We remain of the view that a diversified portfolio, favouring equities over bonds, offers the best prospect of producing inflation-beating returns over the long term.
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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