This year has proved to be a very testing time for investors, much of which has been driven by central banks’ attempts to bring inflation under control through higher interest rates. This has been impacting upon the broader global economy and financial markets for some time, but the problem has been magnified in the UK by the Chancellor’s ‘mini budget’ last week setting out a growth agenda which, to financial markets disapproval, funds tax cuts with further borrowing on top of that required to fund the energy price cap. How much further the process of tightening monetary policy has to go will depend on how effective interest rate rises are in moderating inflation and the severity of any downturn resulting from this.
Clearly expectations of inflation being a temporary issue have been incorrect, in part due to the knock on (energy) effects of the Russian invasion of Ukraine and central banks led by the US are now determined to bring it back under control. That is likely to continue to result in some short term pain for investors and the global economy.
In terms of how this impacts on portfolios, few areas of investment have avoided any negative impact, although for sterling investors holding assets denominated in US dollars has mitigated much of the market weakness there due to sterling’s depreciation, i.e. despite a decline of c. 20% by the US stock market, UK investors have seen level returns so far this year.
Elsewhere, rising interest rates have generally had a negative impact. The most sensitive areas including fixed interest/bonds, commercial property and UK small and mid-cap stocks have been weak due to their greater domestic focus. The outperformance in recent years of high growth potential shares, notably in technology companies, has reversed as higher interest rates reduce the value of future earnings. The rare areas of strength have been from more traditional companies in defensive sectors such as natural resources, oil and gas, healthcare and utilities where demand is less sensitive to economic prospects and/or higher prices have improved profits.
Traditional safe havens such as government bonds have failed to offer any significant protection as UK government bonds (gilts) have fallen more than equity markets this year. The lack of income from gold has impacted negatively on the price although the strength of the US dollar has again been beneficial here for sterling investors. The inclusion of infrastructure funds where the assets, renewable energy projects for example, typically benefit from a link to inflation has though been an area of resilience.
In general, making drastic changes to a portfolio at a time of market/economic upheaval is ill-advised as assets may be sold nearer to their lows, therefore missing out on recovery prospects. It seems likely that markets have already discounted a period of mild recession, they do tend to always be ‘ahead of events’ and remaining substantially invested does enable participation in recovery when sentiment changes, from which time the upturn can be rapid.
That is not to say that no alterations should be made to portfolios as part of the ongoing management. The investment environment is constantly evolving and the pace of events has been particularly rapid over recent years with the policy responses to the pandemic across the world and war in Ukraine, contributing to a shift from the prolonged period of very low interest rates and subdued inflation which put a premium on capital growth in asset values.
If we are entering a period where interest rates and perhaps inflation will be higher than over recent years, then reducing allocations to equity funds more heavily concentrated on companies with lower levels of profit at present but high future growth expectations may be prudent, particularly as more established and reliably profitable businesses typically have higher levels of dividend pay outs which can make up an important element of the total return. There will also be a point where fixed interest/bonds become a more attractive proposition as a reliable source of income with some capital return potential.
It is impossible to forecast future market movements with any degree of certainty and the uncertain conditions for investors are likely to continue into 2023 as economic activity slows in the face of the higher interest rates considered necessary to control inflation and the long term damage it causes. This approach should in time see price rises to more manageable levels, opening up the path to rate stability and cuts which will benefit the areas of investment that have suffered significantly this year. The process of this investment/economic cycle is unsettling but remaining invested in a suitably diversified portfolio, taking defensive action where necessary, is likely to be the most effective approach to achieve longer term investment objectives.
|2022 Year to Date|
|FTSE World ex-UK||-5.17%|
|FTSE Actuaries UK Conventional Gilts All Stocks||-30.19%|
|FTSE Actuaries UK Index-Linked All Stocks||-45.18%|
|S&P GSCI Gold Spot||+11.53%|
Total returns in GBP to 28/09/2022
|Bank of England Base Rate||2.25%|
|Inflation (Retail Price Index/Consumer Price Index)*||12.30%/9.90%|
|UK Gilt 10 Year Yield||4.23%|
* August 2022
Source of data: FE Analytics, www.bankofengland.co.uk, www.ons.gov.uk The content contained in this article represents the opinions of MacIntosh & James Partners Ltd. The commentary in no way constitutes a solicitation of investment advice and should not be relied upon in making investment decisions. Past performance is not a reliable indicator of future results. The value of your investments can fall as well as rise and are not guaranteed.