Market Commentary 28th June 2022
Since our last update, equity markets have continued to exhibit high levels of volatility with the S&P 500 officially entering bear market territory, having declined by more than 20% (in fact 23%) from its January peak, in dollar terms. Sterling based investors have been insulated by the strength of the dollar which tends always to act as a safe haven in times of turbulence, but which has also benefitted from a 0.75% hike in US interest rates, announced at the Federal Open Market Committee (FOMC) meeting on 15th June. The fall in the S&P 500 from January 3rd to 16th June has been 15.82% in sterling terms, still distressing but not technically a bear market.
Some investors had started to anticipate that the Fed would not need to raise interest rates as aggressively in order to bring inflation under control but data for May, published in the middle of June, showed that inflation had not peaked earlier in the year as had been hoped. Indeed, this had been our theory in last month’s update when we wrote that “the outlook for bonds may not be as negative as it has been especially if the Federal Reserve is forced to curtail its plans to hike interest rates as much as has previously been deemed likely”.
Instead, the Central Bank was forced to raise rates by more than it had previously signalled as well as issuing a very hawkish statement implying that it would be prepared to act as aggressively as required to curb inflation. Market sentiment then swung from worries about inflation to fears of a recession. Bond yields have stopped rising (prices have stabilised) and one might have expected equities to fall further but in fact they have risen by almost 7% in the past week1, perhaps this is a classic bear market rally or perhaps because they have already discounted a lot of prospective bad news. There are reasons to be positive. It is still possible to believe that a global recession can be avoided and that central banks can engineer a so-called soft landing. Whilst sentiment is extremely negative, in aggregate consumers do still have savings accumulated during the pandemic with which to offset rising prices. That said, equity market leadership has changed in the past ten days from more cyclical, value-oriented companies which had begun to stage a recovery after years in the doldrums back in favour of more growth-oriented companies which had previously benefitted from the low inflation and zero interest rate policies of the past decade. This implies that investors are more worried about a lack of growth but on a positive note they are also less worried about inflation than they have been.
As clients will know we interrogate our asset allocation and fund selection regularly and rigorously to ensure that we maintain a judicious blend for a given appetite for risk. At each of our quarterly investment strategy meetings we go through performance and attribution in depth and challenge our assumptions. Our next quarterly meeting is in a few weeks’ time and as always we will be thinking hard about whether or not any changes are required. For now, whilst losses are always uncomfortable, particularly when different asset classes, which are supposedly uncorrelated, have fallen in tandem, we feel comfortable that our portfolios do have the right mix of defensive and return seeking investments to generate an above inflation return, over the long term. No-one wants to own bonds when inflation and interest rates are rising but as we have seen markets can very quickly start to worry about the risks of recession and deflation. Fears of stagflation have been stalking the markets this year but whilst energy prices are unlikely to fall back to previous levels any time soon, it is notable that the prices of other commodities such as copper and steel are actually 10% and 12% respectively lower than they were a year ago, whilst iron ore has nearly halved in value over the same period.
What about growth versus value? As alluded to above, growth equities having been sold off very aggressively this year as investors have worried about higher interest rates (future earnings discounted at a higher rate require a lower starting value to be worth the same as before) have staged a rally in the past ten days as investors have become more concerned about slowing growth (if interest rates do not rise further then companies which can continue to grow can command a higher premium). The reverse is true of value equities which have outperformed in the past six months. We recommend that clients have exposure to both growth and value styles of investing with the expectation that the diversification helps portfolios weather short term storms without detracting from their ability to generate longer term returns.
As always, we would like to remind clients that the best way to achieve their investment objectives over the longer term is to remain invested in portfolios that are diversified across different asset classes, geographies and investment styles and which are commensurate with their capacity for loss and appetite for risk.
(1S&P 500, Source: FE Analytics, Bid to Bid, Total Return, local currency, 16/06/22-24/06/22)
28th June 2022
RiverPeak Wealth Limited