Market update report from Investment Director, Steven Lloyd

The economy

We, and many other investors, are worried that a recession might be on the horizon. The Bank of England has warned that the risk of recession in the UK is high and the US Federal Reserve (Fed) is trying to bring down inflation without killing off economic growth.

Whether the Fed will be able to engineer this “soft landing” or not is debatable and, to be blunt, it doesn’t have a great track record. A recent academic paper showed that, since 1955, on each of the three occasions when inflation was above 5% and unemployment below 4% (as is the case now), recession followed within a year. This does not bode well.

Again, there might be reasons to be optimistic. Some of the inflationary pressures have been caused by consumers switching from spending on services to durable goods. As the world locked down during the pandemic, we couldn’t spend on eating out, holidays, or going to the cinema and so many spent on home improvements instead.

As consumption switches back to services from durables, and the supply side hopefully succeeds in increasing production, the price of manufactured goods could fall. There were signs of this happening already in March when US durables prices fell by 0.9% month-on-month. The problem, however, is that because of rising energy costs and lockdowns in China, the supply-side response might be further delayed thus mitigating any downward pressure on prices.

There is a school of thought that excess savings could support the economy, even if wage growth is more than offset by inflation. In the US, estimates suggest that there is over $2 trillion of excess savings, which is equal to about 10% of US GDP. Therefore, should consumers decide to spend this, it could support the economy for a few years:

Bearing in mind a tight labour market, rapidly increasing wages, and the factors discussed above, the outlook for the US economy is highly uncertain. Many strategists expect a recession (after all expansion cannot last forever) but the expected timing varies.

Should the economy avoid a recession in the short term, this could support risk taking and equity and bond prices from here.

Investor positioning & valuations

One could argue that global equities are now more attractively priced following the recent sell-off. That is true but it doesn’t get away from the fact that some markets are still expensive relative to their own history. The chart below shows the valuation of global equities on one measure and we can see that the US is by no means “cheap”:

However, investors appear to be very pessimistic. In the chart below, when the line is moving down, investors are more pessimistic. We can see that pessimism is worse even than in the depths of the Global Financial Crisis in 2008:

This very bearish sentiment could be a contrarian indicator and draw people back into the market in search of bargains.

However, positioning across US investors suggests that, despite the bearishness, investors haven’t actually repositioned their portfolios very much. The chart below shows that equity holdings have barely fallen, and cash has only risen at the margin:

Perhaps then investors are as concerned as we are over the risks of recession but are mindful of the finely balanced arguments both for and against a more benign environment going forward.

How we are navigating these markets

It is fair to say that markets have been very difficult to navigate since the onset of the pandemic, just over 2 years ago. This is particularly true of 2022 so far.

In environments such as this we suggest:

1. Trust in proper diversification across multiple asset types and regions of the world. How different assets behave relative to each other (how they correlate) varies from time to time but the long-term benefits of holding a mix of assets has been proven.
2. Choose your benchmarks wisely. We have written at length about the nuances of performance benchmarks, so it is helpful to choose multiple comparators to get a complete picture of your portfolio performance.
3. Engage with your Advisor and/or Investment Manager. We are here to help you to understand your investments and how current events might be impacting them.
4. Resist temptation to watch your portfolio value. Investing is for the long term and watching the rise and fall of your portfolio on a daily basis only serves to increase anxiety. Advisers and Investment Managers are paid to monitor your portfolio on your behalf so that you don’t have to.

Until next time stay well.