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11th February 2022
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Graham BentleyGraham Bentley

Depending on where you live in the UK, your experience of last month's weather may have been markedly different from that in another's location. England experienced the sunniest January on record, the South and East in particular enjoying record low rainfall. New Year's Day saw temperatures in London hit over 16ºC, yet the North and Scotland suffered snow and the worst of storms Malik and Corrie.

Turbulence in the markets

Perception of stock market turbulence was similarly diverse. In January the FTSE 100 - an index composed of the hundred largest companies quoted on the London Stock Exchange (LSE) - rose by 1.2%, and UK media perhaps naturally led with this index's performance in its daily business news items. A UK-based investor might have considered this a bellwether for equities in general. However, consider that the LSE trades the shares of around 2000 companies. Of the largest 100, a mere ten of them constitute almost 50% of the market by weight. Checking data on the 5th February, only 29 of those 100 companies' share prices had risen over the previous month, ie 71% of the index's constituent shares actually fell in price. The index performance is clearly not the whole story. Furthermore, the index of the next largest 250 UK companies fell by over 6.5%. Now given the UK constitutes less than 5% of the entire global stock markets, in the greater scheme of things the FTSE UK's impact on a globally-diversified investment portfolio might be deemed relatively insignificant - certainly not a leading indicator.

Losses suffered in US, European and Asian markets

Similarly, US, European and Asian markets all suffered losses, with those biased towards technology, eg the Nasdaq 100 being among the hardest hit with a drop of over 7.5% in sterling terms over the month. Investors who might have surmised bonds were a safer haven might have been disappointed with losses UK government bonds of over 3%, and perhaps surprisingly their inflation-linked counterparts also fell by 2%. In summary, it is difficult to find any securities market that rose during the month.

On the cusp of regime change

Investment professionals have got used to the idea that a bull market in shares keeps consumers happy; this experience has been gained over the last thirty years of plummeting inflation, rock-bottom interest rates, and mountains of money pumped into the financial system. As we've indicated for some time in our various commentaries, market participants are beginning to take seriously the idea that we may be on the cusp of so-called 'regime change', where inflation returns and in response central banks raise interest rates in tandem.

Increasing financial burden on households

Investment guru Warren Buffet has likened the relationship between equity prices and interest rates as being akin to mass and gravity; the moon's gravity is one-sixth of earth's so weightlifting takes one-sixth the effort. Rising share prices have been the overwhelming experience in the markets for more than a decade. A stronger force of gravity makes lifting the same object more difficult; the Bank of England has now raised the base rate twice in three months, forecasting inflation to surpass 7% by April - a rate not experienced in over three decades. The promised rise in National Insurance deductions, and an imminent and significant increase in the maximum amount a utility company can charge an average customer in the UK per year for the electricity and gas they use, will further increase households' financial burden. Stock market growth may be slower as a consequence.

Ironically, after a decade of depressed values Commodity prices are surging, with the S&P index of commodity prices rocketing almost 13% in January - the flipside of the inflation coin.

Investor’s attention drawn to best performing areas of the market

Independent central banks are generally mandated to control inflation, not support stock market performance, so their withdrawal of liquidity will mean investors have to become more discerning in their selections. Investors' attention will increasingly be drawn to those areas of the market that are likely to do best while inflation persists. These are occupied by businesses who have few serious competitors, where irrespective of demand continued capital investment is unimportant, and whose products we want to (or indeed must) buy, irrespective of price.

Cementing our approach to fund selection

For those of us old enough to remember the mid-1970's and a period of 'hyper-inflation' and 15% interest rates, current and projected levels of both feel rather less ominous than might otherwise be the case. Frankly, an investment strategy of selecting quality companies with limited competition, who make products we want to buy or provide services we want to use, makes sense in any environment. Our approach to fund selection aims to reflect this belief, while our asset allocation strategy recognises equity earnings are far more likely to retain and increase purchasing power than bonds. However, at the same time, we remain wedded to the notion that dampening volatility through diversification across equities, property, commodities, and bonds should provide our clients with peace of mind through any periods of market turbulence.

And finally,

In Shakespeare's Julius Caesar, while considering various conflicting omens before battle, Cassius declares to Melissa he is "fresh of spirit and resolved to meet all perils very constantly". Wise investment managers might adopt the same philosophy given January's welcome to 2022.

Graham Bentley
Chief Investment Officer


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