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1st June 2022

Steven LloydSteven Lloyd

From Steven Lloyd, Investment Director, Ascot Lloyd

As I write this, it is the 30th May and we're all looking forward to a long Bank Holiday weekend. Consequently, I've been asked to submit my commentary a few days early, so apologies if I fail to incorporate any significant issues occurring on the last day of the month.

So far in 2022 we have focussed your attention on stock markets' realisation that accelerating inflation is more than a post-COVID phenomenon, and on how the world's central banks are having to respond through a fundamental change in monetary policy. In May we saw updated year-on-year inflation figures suggesting that UK inflation had reached 9%, and yet if we chat amongst ourselves, we might find our actual experience of price rises is even more extreme.

This coming weekend will be replete with street parties, many of us travelling to family affairs. With an accompanying decent weather forecast, the nation will be in festive mode with al fresco dining probably high on the agenda. Inflation certainly will have an effect here - the pump prices of diesel and petrol are respectively up 22% and 16% so far this year according to the UK Government's official statistics*. As for party fare, inflation has certainly taken a bite out of your burger. The price of a bread roll is up over 10%, Beef mince is up 15% and bacon almost 18%. The humble lettuce costs almost 13% more than it did 5 months ago. The good news is that a tomato's price remains virtually unchanged.**

The one area where inflation remains subdued is, alas, share prices. Despite a bounce in prices towards the end of the month, the main technology companies: Facebook, Amazon, Apple, Microsoft, Nvidia, Google and Tesla have given up all the gains they amassed in 2021. Various commentators are beginning to speculate on 2022 being deemed to be a 'bear' market. This is generally used to describe a market down 20%, but frankly this is an entirely arbitrary figure - quite why a 20% fall should take on great significance versus a market fall of 1% less is beyond me, but there it is. The UK market still flatters to deceive - the FTSE 100 is up 3% in 2022 but the next biggest 250 companies are down almost 13%. The US equity market flirted with the 20% negative milestone in mid-May but recovered a little before the Memorial Day weekend.

Meanwhile, so-called safe havens have proved to be something of a misnomer. By the above definition, index -linked gilts are already in a bear market. That appears counter-intuitive; doesn't index-linked mean that those gilts are protected against inflation? Well, yes and no. Any bond is in effect an IOU, characterised by two elements: the coupon, i.e. the promised rate of interest to be paid, and the capital value, represented by the price. An index-linked bond's interest payment will increase in line with inflation for sure, but generally from a very low starting point, typically less than 0.2%. So a £1000 gilt coupon paying say £1.25 annual interest would, with 9% inflation, see that interest payment rise by 11p. Meanwhile, the capital value of any bond is inversely related to inflation and interest rates; the longer the period to a bond's maturity date (when it pays back the borrowed £1000), the greater the bond price's sensitivity to those rates changing. Higher inflation reduces the value of the redemption amount for an index-linked bond just the same as any other bond. As interest rates rise, the interest yield must rise to compete, and as our bond's coupon is fixed at 0.125%, the only way that can happen is if the bond's price falls. The total real yield (yield to redemption less inflation) on a 30-year index-linked gilt is currently minus 1.5%. For that yield to turn positive, the bond's price would have to fall by nearly 40%. 

It may be we are beginning to see some silver linings, however. Bond yields in general look more attractive at these levels from a risk/reward viewpoint. Prices of industrial and precious metals appear to be stabilising, and 'boring' dividend-paying companies share prices have risen by 10% and more so far this year. Active management usually does best in conditions like these, where passive exposure to broad indexes (whose constituents' presence reflects accumulated 'good times' performance) acts as a constraint on future growth. We continue to monitor the activity of our selected fund managers to ensure they are 'sticking to their knitting', ie doing what they have proved to be best at rather than ducking and diving into unfamiliar areas of the market.

Have an enjoyable Jubilee weekend, and we'll be back as usual next month.

Steven Lloyd

Investment Director, Ascot Lloyd

*Department for Business, Energy & Industrial Strategy
Energy Prices Road Fuels and Other Petroleum Products
Weekly Road Fuel Prices
Publication date 24 May 2022

**Source: Bureau of Labor Statistics and Goldman Sachs Asset Management. Price change of select hamburger ingredients (YoY, %)


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