Market Commentary from the Brooks Macdonald Group - August 2022
Global equities rebounded in July and the first few weeks of August as investors grew hopeful that major central banks, particularly the US Federal Reserve (Fed), would need to slacken the pace of interest rate rises because of slowing economic growth. Some solid corporate results in the US and Europe provided further cheer, although soaring inflation continued to exert downward pressure on stocks during the month.
UK stocks rose, helped by some favourable corporate results and optimism about a possible slowdown in monetary policy tightening. Equities also moved higher as Prime Minister Boris Johnson announced his resignation, following a number of controversies over his leadership. The annual inflation rate increased to 9.4% in June – a 40-year high – from 9.1% in May. UK GDP grew by 0.5% in May – beating forecasts for a contraction – after shrinking 0.2% in April. We have a positive outlook for UK equities, but we make a distinction between the UK equity market versus the UK economy. Looking at the MSCI UK equity index, UK equities have around three quarters of their revenues derived from outside the UK. The relative valuation attraction of UK equities makes up an important component of the ‘value’ tilt within our [equity] barbell approach to asset allocation (with value & cyclical stocks on one side of the barbell, and growth stocks on the other).
US equities made very strong gains, buoyed by some positive corporate results and the Fed’s hints that it could ease its policy tightening plans later in 2022. For the second consecutive month, the Fed raised rates by 75 basis points (bps), to 2.5%, as annual inflation hit a 40-year high of 9.1% in June, up from 8.6% in May. The US economy unexpectedly fell into a technical recession as it shrank by an annualised 0.6% in the second quarter, following a 1.6% contraction in the first quarter. Continued monetary policy tightening helped the US dollar index hit a 20-year high around mid-July. Balance remains key, particularly given the current inflation and monetary policy risks, equity valuations derated during the quarter, despite a broadly resilient earnings outlook. The US continues to provide the ‘growth’ tilt within our [equity] barbell strategy.
In this risk off environment, investors would typically look towards bonds for their defensive characteristics, although bonds have suffered in almost equal measure as a result of the higher inflation and interest rate moves. The sector of late has seen a slight slowdown as yields have fallen and equities have started to perform building on a run of 4 consecutive weekly moves higher as of the 22nd August. Yields on core government bond markets fell (prices rose, reflecting their inverse relationship) as the Fed signalled that it could ease the pace of interest rate rises later this year. In the corporate debt market, US investment-grade and high-yield spreads tightened. Looking forwards, the outlook for sovereign yields is more balanced. Given a softening in the economic outlook in aggregate, should price pressures start to ease, this might provide greater support for shorter-dated bond prices which we currently favour.
We continue to look for opportunities to build in inflation protection, with equities providing a longer term linking but this is not a direct correlation in the short term. Elsewhere structured return and alternatives will be valuable diversifiers and will make up an important part of portfolios moving forward. In the short term, it’s easy to point to several risks that could drive further volatility, although we’re also very conscious that the market, while not panicking, is certainly bearish and the price movements to date are pricing in some of the outlook discussed above. As we’ve seen over short periods this year, any improvement on this outlook (regarding economic growth, inflation, or monetary policy) could help support markets from here and therefore remaining invested through difficult periods has proven to be the correct strategy over the long term. History suggests that the best days often closely follow the worst days so trying to time markets during periods of extended volatility often leave investors feeling frustrated.
We maintain the belief that balance is key within portfolios considering the current backdrop. Inflation may well tick higher in the coming month or so as we await the effects of increased energy prices and global demand, but our base case is that it will soon start to normalise, meaning that current market levels may well provide attractive opportunities over the medium to long term.
Important information
The performance indicated for each sector should not be taken as an expectation of the future performance. Investors should be aware that the price of investments and the income from them can go down as well as up and that neither is guaranteed. Past performance is not a reliable indicator of future results. Investors may not get back the amount invested. Changes in rates of exchange may have an adverse effect on the value, price or income of an investment.
Investors should be aware of the additional risks associated with funds investing in emerging or developing markets. The information in this document does not constitute advice or a recommendation and you should not make any investment decisions on the basis of it. This document is for the information of the recipient only and should not be reproduced, copied or made available to others.
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