Market Commentary - 16th August 2022
Advocates of "sell in May and go away" (not something we'd ever recommend) might have been feeling quite smug in June but would have missed out on a remarkable rally in July and August. Remarkable not only for its extent but also because July was also the month when Central Banks raised interest rates by record beating levels in an effort to combat inflation.
In the past six weeks from 24th June to 15th August the MSCI ACWI has risen by 9.74%. The best performing market has been the US which has benefitted from a resurgence in technology shares with the S&P rising 11.93% (in sterling terms; in local currency it rose 10.01% given ongoing weakness in sterling relative to the dollar). The S&P 500 has now recovered half of its losses sustained between its January peak and June nadir. Japan also outperformed (+10.14%) whereas Europe (+5.91%) and the UK (5.15%) fared less well though still generated strongly positive returns.1
Usually, rising interest rates have a negative impact on sentiment and these concerns have been reflected in the market falls in the first half of the year but it seems investors are now beginning to look forward to a time when central banks pause or even start to cut rates. The recent outperformance of growth versus value stocks and the fall in bond yields also implies investors are worried about slowing growth. Indeed, the US has now experienced two quarters of negative growth, which according to some definitions meets the threshold for a recession but it is hard to argue that the economy is suffering to that extent when the employment numbers remain so robust with close to 400,000 jobs being created every month. The rope that the Federal Reserve and investors are walking along is tight, with uncontrolled inflation on one side and recession on the other. It remains to be seen whether or not interest rates are high enough to bring inflation under control without damaging corporate returns to a significant degree. Recent publications have been encouraging with a slew of data that has been weaker than expected including the fact that the headline US CPI index for July was unchanged from June. Whilst wage expectations are still rising, both raw material prices have moderated and consumer and business sentiment surveys suggest that the peak in concern about inflation is behind us.
We can’t yet know whether or not this is a bear market rally or the start of a new bull market. A so-called soft landing in which inflation is brought back under control without a major recession does appear to be a distinct possibility but such is the strength of this rally that there is definite scope for disappointment, especially if it takes longer for the Federal Reserve to change direction, and the surprise announcement yesterday that the People’s Bank of China’s was cutting interest rates suggests that the global economy remains delicately poised.
All in all, it’s a powerful reminder that stocks can rally when you might be least expecting them to and that it’s better to remain invested through thick and thin rather than trying to predict market outcomes.
At our recent Quarterly Strategy Meeting held in July we discussed the inclusion of a strategic bond fund and also whether or not to introduce an allocation to alternatives (commodities, hedge funds and the like).
A strategic bond fund is one where the manager is able to invest across the credit spectrum including both high yield as well as investment grade and is also able to manage the duration of the portfolio (a measure of the sensitivity to interest rates) and in some instances being able to adopt a negative duration stance. This ability is obviously appealing in a rising interest rate environment. Exposure to gilts and corporate bonds has not fared well in the first half of this year as interest rates have been rising, so it is tempting to consider the inclusion of a fund that can theoretically make money in all scenarios. The problem is that they so seldom do. Our analysis of the IA Strategic Bond sector, which includes ninety funds, shows that only two generated a positive return in the first half of 2022 and fifty-five funds declined by more than 10% over the same period. It is difficult to predict how a bond fund is going to behave when the manager has the discretion to change the asset allocation aggressively and often we might find that they have a more constructive view on for example, high yield, when we are looking to the bond allocation in our portfolios to be more defensive. Two other factors are cost and complexity. Strategic bond funds are not cheap and they also use derivatives in order to achieve the exposures they are seeking. This is not necessarily a bad thing but we always want to ensure that we are getting value for money and that the additional input entailed by us and our clients is justified.
Similarly, alternative funds which have been gaining in popularity in recent months as investors have sought to mitigate inflation risks can also be unduly complicated. Exposure to commodities can only be achieved via derivatives and after considerable thought we have concluded that for now we prefer to achieve exposure indirectly through the likes of the big energy or mining stocks held in the equity funds we recommend.
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.
(1 S&P 500, TSE TOPIX, MSCI ACWI, FTSE World Europe ex UK, FTSE All Share, Source: FE Analytics, Bid to Bid, Total Return, GBP, 24/06/22-15/05/22. )
16th August 2022
RiverPeak Wealth Limited