Quarterly Investment Newsletter: Winter 2022

The last quarter of the year saw some relief for investors who had been hit from all sides throughout 2022 as markets rallied on the belief that the economy was perhaps showing enough signs of stress to persuade central banks to consider slowing, and then stopping interest rate rises. Central banks, for their part, remain consistent in their messaging that markets may be being overoptimistic. Nonetheless, global equities rose by more than +7.5% in the fourth quarter, albeit for UK based investors this return was tempered due to the effect of Sterling’s appreciation against the US Dollar after the Government displayed more fiscal prudence in its latest budget. Better forecast public finances also caused gilt yields to fall meaning a positive return for investors, while gold also rallied.

Received wisdom is that markets front run economies, i.e. stock markets will sell off before economic difficulties show up either in statistics or the real world. By the same token, once evidence of a recession materialises, markets can again be looking ahead to easier monetary policy and a recovery in corporate earnings (save for those companies that might have fallen by the wayside during the contraction). Thus, the three key questions for the moment are: Will western economies officially enter recession? If so, have markets already sold off enough to compensate for loss of corporate earnings? And finally, will this cause central banks to start to cut interest rates or will they still fear the spectre of lingering inflation? As ever the questions are obvious, but the answers more elusive. Consensus opinion, for what that is worth, is that Europe and the UK will suffer more than the US in economic terms, but that US stock markets are still perhaps a little too keenly priced despite their significant sell off last year.

The good news for economies and markets is that inflation has peaked, and the base effects of the calculation mean that we can reasonably expect a rapid fall in the headline inflation rates during the first half of the year. This though does not necessarily mean that inflation will fall back to the low levels that we have been used to for the past few decades, and it ought to be remembered that the 2% Bank of England target is a fairly arbitrary number. Many elements continue to impact the inflationary outlook as the world settles into a post pandemic order with much changed geo-politics. The reopening of the Chinese economy will change the dynamic again with boosts for both supply and demand sides of the inflation equation, whilst the situation in Ukraine continues to force a remodelling of energy supply chains, and manufacturers choose to manage production risks by shifting supply chains to alternative emerging markets.

Debt levels in all areas of the economy, government, corporate, and consumer, will continue to be a significant factor for future growth prospects. Governments, having dug deep to cover the pandemic stresses and now the energy crisis find themselves fiscally constrained. Some companies will experience the pain of having to refinance debt at higher interest rates, whilst the same is true for homeowners and new buyers who face rising costs and falling house values. For debtholders whose income can keep pace, a period of above average inflation may not be entirely negative.

At our January meeting the Investment Committee voted to maintain our neutral position in equities, but to amplify the more defensive nature of the underlying holdings. We prefer quality companies with steady income streams, and a track record of paying dividends.

David Baker – Chief Investment Officer