News & INSIGHT

Those with a keen interest in financial markets will have noticed that 2022 has brought with it the brewing of a dramatic storm in the more ‘glamorous’ areas of the stock market.

The US S&P 500 index is down 8.1% year-to-date (at 27^th Jan), while the ‘go-faster’ Tech-biased Nasdaq is down even more at 13.7%.

The high Growth style of investing, epitomised by the story of technology companies “changing the way we live our lives”, has faced relentless selling pressure. This has driven down American stock markets, due to the disproportionately large weightings that these areas represent within US bourses. The same dynamics are also playing out globally, simultaneously affecting other major regional stock indices.

If you are not a close follower of financial markets or only follow the UK’s FTSE 100 index, you might be surprised to learn of this mini drama. This is because the FTSE is up 2.3% over the same time period.

To understand why some investment areas are currently feeling acute pain while others are coming out seemingly unscathed, it is necessary to revisit the polarised dynamics that have characterised the investment world of the past few years.

Financial markets have effectively been playing out the financial equivalent of the ‘tortoise and the hare’ story, much to the frustration of any ‘fundamentally’ focussed investor. In the financial version, the Tech and other disrupter high-flyers (trading at very high valuations) continued to soar (despite eye watering price tags) while more traditional investment types (trading at sensible valuations) remained grounded. Most recently – in effect since the first vaccine discovery in November 2020 – this tide has started to turn, becoming more violent since the start of 2022.

It is important to point out that we are not against inevitable change when managing your investment portfolios. Instead, our greatest concern was always that such popular areas of the marketplace had become excessively overbought, leading to – by historical standards – very high valuations. If the past serves as a good guide, such stories never tend to end well. The only debate is usually for how long and by how much the bubble might inflate before it inevitably pops. For this reason, we chose not to back the seemingly unstoppable ‘hare’ based on a long-term understanding of financial market human behavioural dynamics. We prefer to remain disciplined to the long-term fundamental rules of the game as we see them.

Although markets never move in a straight line, it seems that a turning point may now have been reached. This is due mainly to higher inflation expectations, as market participants came round to believe inflation might actually be less temporary than first thought. As a result, more powerful expectations of interest rate hikes in the US (and globally, with the Bank of England recently hiking rates by 0.25%) have provided the catalyst for change, upsetting what to us always looked like a fragile set-up.

The first vaccine announcement in November 2020 served as a good marker of when the tide started to turn. It acted as an economic recovery catalyst and the change has been slow and gradual but turning more violent of late.

The investment types starting to come back into vogue include cheaply priced Value stocks, including UK Equities and generally most developed market stock markets, aside from the expensive headline US market (due to its large Tech weighting). Property, Commodities, defensive stocks – including Infrastructure – have also benefitted from this rotation. It might not come as much of a surprise to learn that these investment types are all generally perceived as inflation beneficiaries (or of rising interest rates in the case of Financial stocks, a Value sector), which makes sense given the sudden reassessment of this risk factor.

Fast Growth, Tech and higher risk Mid and Smaller Cap Equities have lagged. Their valuations are often based upon more distant growth prospects materialising (never guaranteed), which mathematically benefits from lower interest rate expectations or hurts when rates are rising. This is based on the fundamental way in which companies are always priced relative to risk-free returns ie interest earned on cash savings.

Interestingly, we note that High Yield bonds (the debt of low quality, financially less secure companies) has not really been affected by the recent turbulence. To us, this suggests the rotation between investment types does not look to be a function of weaker economic growth prospects. Rather, inflationary pressures are arguably more a function of continued economic progress, as well as other one-off factors such as older workers choosing early retirement thereby reducing the supply of available workers, leading to wage increases, which feeds into inflation. Again, this too makes sense from the perspective that cheaply valued, cyclical areas of the market may stand to gain.

Turning to other asset classes, not surprisingly, Inflation Linked bonds have outperformed conventional Bonds over the past year. Gold has edged up very slightly over the past three months, but has generally offered dull performance due to its defensive properties at a time of escape velocity since the initial Covid shock.

After a disappointing 2021 (Large Cap Tech & China faced pressure earlier than others for their own China-specific reasons), Emerging Markets have held up well during 2022. Unsurprisingly, Japan, being a large importer of energy during a period of soaring prices, has struggled. However, Japanese stocks appear to offer reasonable value looking ahead. The FTSE 100 is firmly on the performance global leader board over the past 12 months, albeit there is still significant ground to make up on a multi-year view.

Summarising, investing is very much about patience and not getting carried away with greed and fear. We are encouraged that value strategies are making back much of the lost ground in the ‘hare’ era. Importantly, the investments we hold on your behalf are not giving us sleepless nights during what might be proving to be a more stressful time for many.

The details, views and opinions expressed above are KMD’s, can change at any time and are not intended to be advice or a solicitation to make an investment. Professional advice should be sought before acting on any information contained in this document. The value of investments can fall as well as rise and your capital is not guaranteed. Past performance is not a reliable indicator of future performance.

This week marks the anniversary of the Pfizer/BioNTech Covid-19 vaccine announcement, an important milestone. Other leading pharmaceutical firms launched vaccines of their own shortly after, allowing governments throughout the world to offer doses to their populations on a mass scale. One year later, the data suggests the vaccines have been very effective at dampening the risks posed by the virus.

As would be expected (and in anticipation of such an outturn), financial markets reacted very strongly since ‘Vaccine date’, taking ‘confirmation’ that economic conditions would inevitably improve from dismal to buoyant. The rising tide lifted all boats, with global stocks since rising just under 30% (at the time of writing), as measured by the MSCI World index in GBP terms.

Economically sensitive, cheaper stocks (Value) outperformed aggressively for roughly six months as investors rotated from recent winners, such as Work From Home Technology companies and other market darling Growth stocks, into beaten up recovery names. Having fallen further, the recovery stocks had more to gain if they could survive to see economic normality. Mid and Smaller Company stocks rose at an even greater pace than Large Cap stocks, for similar reasons; smaller companies are generally more sensitive to domestic economic conditions than their larger, multinational counterparts. The UK FTSE Small Cap ex-investment trusts index was at one point up almost 70%. Over the one year since the virus announcement, the FTSE 100 index was on the verge of outperforming all other major stock market regions, including Europe, Japan and Emerging Markets, before just being pipped at the post by the US. This positive outcome marks a welcome change from recent years.

As ever though, it was not always plain sailing. Inflation concerns surfaced early in 2021 as supply bottlenecks and other shortages caused short-term headaches to companies and consumers. Product supply chains were hampered notably under the stresses of economic lockdowns, leading to shortages in goods such as computer chips and sharp rises in global shipping rates (which affect) the pricing of imported products that consumers buy). Several older workers also took the opportunity to claim early retirement, while the policy impact of Brexit saw a cessation in the usual influx of foreign immigrant workers, both of which contributed to labour shortages, most publicised in areas such as lorry driving. Oil prices also doubled over the year, feeding into all manner of transport and manufacturing costs.

There is much debate in financial markets as to whether widespread price increases might prove to be a temporary phenomenon – as a result of Covid disruption – that will eventually work itself out, or whether higher inflation might prove more permanent. If the latter, conventional investment portfolios could potentially face a degree of turbulence given high valuations for both stocks and bonds on many counts. That said, our judgment is that the Pinnacle Financial Services & Wealth Management portfolios (as they look today) would be expected to fare relatively well due to the inclusion of many inflation-beneficiary asset or investment sub category types.

Unlike the party mood seen in Developed country stock markets, Emerging Markets have struggled since early 2021, the point at which inflation concerns spooked markets. Generally speaking, if global central banks such as the Federal Reserve and Bank of England are seen as having to turn up interest rates in order to choke off inflation risks, less money tends to find its way to peripheral countries.

Events in China also made the headlines, not helping whet the appetite for Emerging stocks. Evergrande, the world’s most indebted property developer, defaulted on its debt, providing echoes of the global financial crisis. However, it must be pointed out that over 90% of Evergrande’s debt is owed locally within China, so the chances of this being an international debt problem via a chain reaction from bank to bank appears unlikely. Rather, problems are likely to be mopped up internally within the Chinese financial system – the authorities have many levers to pull. That said, property market turmoil generally leads to significant debt problems within the banking system, so there is certainly the potential for these to act as a drag on Chinese growth, regardless of deep pockets, offsetting progress elsewhere and those levers. Should Chinese growth come under pressure, this in turn could dampen the near-term prospects for those doing business with China (Asia Pacific region, Germany and Europe as key exporters, for example).

As a result of this and general signs of US growth paring back modestly, Bond markets appear to have become more concerned about slowing global economic growth prospects since the Summer. Since then, much of the Value vs Growth dynamic has reversed (albeit the rising tide has lifted all boats roughly equally high at the time of writing). Key central banks, including those in Canada, Australia and the UK, have sought to quell fears that they might leave an overheating economy unchecked. Consequently, this has taken the edge of some of the recovery plays since the Summer.

As would be expected in a rising tide environment, defensive assets proved dull over the past year. Gold declined – in mirror image to risk assets – for the first few months after the vaccine announcement was made, while UK Government Bonds came to lose circa 5% of their value. Since then, such instruments have broadly moved sideways, as have Corporate Bonds, over the entire period. Defensive share types also failed to join the party, with Utilities, Infrastructure and Consumer Staples (Food and Beverage) companies, for example, only registering slight gains, despite the rising tide.

All in all, 2021 looks set to close as a bumper year for investment portfolios. As always, though, we remain mindful of the need to consider the relative prospects for the tortoises as well as the hares.

The details, views and opinions expressed above are KMD’s, can change at any time and are not intended to be advice or a solicitation to make an investment. Professional advice should be sought before acting on any information contained in this document. The value of investments can fall as well as rise and your capital is not guaranteed. Past performance is not a reliable indicator of future performance.

Global stock markets have continued their upward march since our last market commentary in April. When compared to the darkest days of March 2020, the US S&P 500 stock index has now doubled in value and broadly similar, albeit slightly less impressive, figures are being witnessed by other key market exchanges.

The effectiveness of leading vaccines has largely been confirmed by the data.  Covid-19 fatality rates have been vastly reduced in recent months whilst the risk of transmission throughout the population has also notably faded.

Not only is this encouraging in itself, but governments have collectively, for the most part, responded by getting their acts together rolling out supplies across the globe, no doubt incentivised by the financial prospect of a return towards economic ‘normality’.

This positive vaccine picture gives us greater confidence that the worst might be behind us. Of course, we must not forget that no vaccine is 100% effective and further mutations and variants could yet change the picture. However, the facts would suggest that a light can now be seen at the end of the tunnel as far as economic – and hopefully daily – life is concerned. Inevitably there will be winners and losers from the changes brought to the world. For example, commercial property landlords might face new pressures from changing work and shopping habits, but it would appear that ‘business as usual’ is getting closer.

Notwithstanding the progress made in taming the virus during the first half of the year, a defensive rotation was simultaneously taking place beneath the surface in financial markets. Inflation fears (prevalent in January and February) receded almost as quickly as they prevailed! Related rising bond market rates retreated following a brief but aggressive rise. For example, US 10-year Treasury yields rose from sub 1% in late 2020 to almost 1.8%, before falling back down to 1.27% at the time of writing. UK Gilt yields followed a similar pattern. Such examples of market zig-zags in the short-term confirm to us the importance of not losing sight of the longer term picture.

As economic growth expectations weakened and inflation fears petered out more recently, some of the shine was taken off a chunk of the recovery trade. Consequently, Value, Commodity and Smaller Cap shares stalled in June as market participants looked for shelter in larger, ‘safer’ Growth stocks with greater structural prospects (but also with greater price tags).

Less aggressive economic growth forecasts might also serve to provide an important extended signal that the zero interest rate punchbowl might not be taken away any time soon. This is important when considered alongside the enormous global debt pile that has ballooned as a result of fighting the pandemic with economic stimulus. With such a large debt mound to work through, it is inconceivable that policymakers would wish to raise their own financing costs. With reopening prospects looking rosier, that seemingly offers something of an extended set of ‘Goldilocks’ conditions (not too hot, not too cold, but just right) for a little longer yet – hence explaining the continued sugar rush dynamics.

We have written several times that we feel some areas of global stock markets appear excessively valued, matched only by the degree of their popularity. In particular, US Tech/Growth names fit the bill, with these forming a large proportion of major US indices (circa 30%). Furthermore, the US stock market itself now represents nearly 60% of global stocks by value (roughly doubling from the level of a decade ago). This has been fuelled by the increasing popularity of the ‘FAANG’ Tech stocks, ESG (Environmental, Social, Governance) trends driving money into the same stocks, a shift toward passive investments that track the largest global stocks and momentum trades. All these are providing a wall of money that appears less concerned with elevated valuations, but that continues to extend this trend further still. Bearing this in mind, we continue to exercise caution with regard to areas of extreme popularity where we believe high valuation levels might come to pose a concern at some point. But until then, the music continues to play and everyone is up dancing.

The FTSE 250 Mid Cap index and UK Small Caps have surged over the past six to nine months since the recovery trade switch was flicked. Sterling assets are starting to get noticed again now that the worst of the Brexit uncertainty appears to have passed. The FTSE 100 index has fared well, albeit less spectacularly than its younger siblings. European stocks, which are more geared to global economic recovery, have also started performing over the past six months or so.

All in all, markets are continuing to absorb good news, but we remain aware that much complacency seems apparent with regard to high valuations in general. Much of this is due to the assumption of low interest rates for the foreseeable future.

The damage that unexpected inflation could cause to both components of a classic 60/40 Equities/Bonds portfolio is never far away from our minds. Should such a scenario prevail, we believe our more rounded exposures to portfolio construction and consideration of many of the historical drivers of long-term portfolio returns, could provide a greater shelter from such forces, as well as possible beneficiaries in many cases eg Commodity stocks, Value, Gold, Absolute Returns.

Ultimately, we will continue to manage your investments with discipline and without distraction in what we believe to be the most appropriate style – leaning into areas where we see value and exhibiting caution in those where we feel such a stance is warranted.

The details, views and opinions expressed above are KMD’s, can change at any time and are not intended to be advice or a solicitation to make an investment. Professional advice should be sought before acting on any information contained in this document. The value of investments can fall as well as rise and your capital is not guaranteed. Past performance is not a reliable indicator of future performance.

The state of the world’s health seems to have turned a corner since our last  investment communication. Notwithstanding the terrible situations in those countries struggling to get on a grip on the pandemic such as India and Brazil, at last there appears to be real hope that COVID-19 will be defeated sooner rather than later.

Although it was inevitable that the progress of individual nations has varied, it is shameful that political ideologies and squabbles have taken priority over human life in too many instances. Thankfully the UK and US administrations have placed considerable focus on their vaccination efforts, as have some smaller nations such as Israel, bringing with it a reduction in transmission rates

The hope is that something closer to daily life will now follow, at which point much of the lost ground of the past year could potentially be made back in terms of both economic recovery and personal freedom.

Against this backdrop, it was perhaps not surprising to have seen Value/Recovery stocks surge since the first vaccine announcement was made in early November. Smaller companies, with their increased sensitivity to global economic growth, also outperformed.

Although the entire stock market tide rose, highly priced Growth/Quality/Momentum stocks (in general terms, past winners of recent years) have struggled in a relative sense since the first vaccine announcement in November. Global Technology (+9.6%) and Healthcare (+2.2%) have seen relatively muted gains compared to Financials (+28.4%) and Commodity Producers (+35.6%). [MSCI World sectors measured in GBP terms between opening prices 09/11/2020 to 20/04/2021]. There is talk that this rotation into ‘out of favour’ sectors is the beginning of a longer trend. Either way, the Pinnacle Financial Services & Wealth Management portfolios have enjoyed this turn in sentiment and are well positioned if the new momentum does persist.

Commodities prices have trended upwards in line with anticipated economic demand. There is a suggestion that notably higher demand could create supply shortages and inflationary squeezes. Supply chains have also been disrupted by the impacts of semi-closed economies – notably in semi-conductor chips – in which Sino-American tensions have also become elevated.

Whether or not inflation may come to rear its ugly head has become a big discussion point in financial market circles in recent months. Central banks are keen to introduce some mild inflation into the system as it would be a useful way of helping erode some of the gargantuan public debt pile by stealth.

According to central bankers, although central bank policy interest rates globally look set to stay on the floor for several years, bond markets have started to price in a legitimate case for higher interest rates sooner than was generally expected back in late 2020. This will no doubt please savers.

As a result, global bond yields spiked rapidly during January and February causing significant losses to conventional defensive fixed income Government bonds. US Treasury Government Bonds saw their largest quarterly decline in 40 years, justifying our light stance with so-called ‘riskless’ bond investments. (Nothing is riskless if you overpay).

It was not only conventional Bonds that fell in value. ‘Bond proxy’ defensive equity instruments such as Consumer Staples, Utilities and Infrastructure stocks also struggled, as did Gold, despite the longer-term arguments for the yellow metal in the event of heightened inflation prospects. But in the short-term, the defensive stance lost that tug of war.

Turning to global stock markets, our taking of pole position on vaccines meant that British stock markets powered ahead against global yardsticks.  For a similar reason, US equities also outperformed, despite their heavy Tech and Healthcare weightings – other areas did the heavy lifting.

In currency markets Sterling rallied, while UK Small and Mid Cap stocks outperformed to an even greater extent than the FTSE 100. Sterling assets look like they are beginning to play catch-up after being left on the ‘naughty step’ in recent years.

In the Emerging Markets, Brazil and India look to be under immense stress from surging infection rates and hospital infrastructures struggling to cope. Unlike their developed market counterparts, general rising indebtedness levels in the emerging world could potentially pose more serious financial credibility problems. Large developed Western countries have the keys to the printing presses, whereas emerging countries have traditionally faced little choice but to keep their houses in order otherwise they run the risk of traditional financial crises. Ensuring that those in the developing world receive access to vaccines will be critically important in avoiding this fate at a difficult time for their people and economies.

On the other side of the Channel, political bickering and inaction in Europe looks to have presented the real risk of a third virus wave across much of the continent, in contrast to the proactivity demonstrated in the US and UK. Asia also looks to have the virus and economic situation largely contained, highlighting yet again the case for regional diversification within investment portfolios at all times.

Wrapping up, financial markets have continued to progress to dizzy new heights, hitting new peaks on many international stages. This has been fuelled in part by optimism and also due to the immense global fiscal stimulus packages that have been put in place, leaving the financial system awash with cash. The inflation hawks and gold bugs are starting to speak up as expectations for higher prices creep in.

Stock and bond market valuations are both on the high side, albeit there is polarisation between the various camps. The real elephant in the room would be that unexpected inflation could threaten equity and bond markets simultaneously. Given the risk posed by this dynamic to traditional bond and equity portfolios, we are mindful of the need to remain vigilant on this count.

It would appear that 2021 has got off to a very good start, but by summer we are likely to be in a position to know whether that bullish optimism today can be justified by the data. Fingers crossed that it can.

The details, views and opinions expressed above are KMD’s, can change at any time and are not intended to be advice or a solicitation to make an investment. Professional advice should be sought before acting on any information contained in this document. The value of investments can fall as well as rise and your capital is not guaranteed. Past performance is not a reliable indicator of future performance.

The disconnect between unstoppable financial markets and deteriorating global economic fundamentals continues to widen as the world maintains its efforts to manage the spread of COVID-19. If anything serves to remind us that the stock market is not the economy, this is certainly it.

The huge stimulus packages put in place by the authorities – for example the US Fed policies measured in $ trillions and the latest €750bn European recovery package – have, in effect, put a floor in place for financial asset prices, creating a tide of global liquidity.

Much of this wall of money – hot off the financial printing presses – is finding its way into global asset markets, pushing many stock and bond prices close to pre-virus highs and, in some cases, beyond.

This apparent resultant steadiness may, on the surface, suggest that things are returning to normal, but financial market professionals know that there are notable lessons from historical bear markets that we must observe. When the authorities put a floor in place (especially via co-ordinated action from multiple central banks) despite dismal news and outlook, asset prices tend to then find the potential to recover, laying the foundations for moving on and this same pattern is presenting.

Meanwhile, in the ‘real world’, it is becoming evident how differing virus containment strategies (to simplify) have led to diverging outcomes between countries eg. US deaths are looking of great concern in comparison to those in Europe, while trends are also worrying in India and Brazil.

On the whole, mortality statistics would suggest, positively, that knowledge on how to contain the virus and slow its spread/impact appears to be increasing. Although it could be argued that perhaps with wiser, older generations being understandably more cautious and sensibly staying at home, they are keeping out of trouble and away from the grimmest category of the published statistics.

Unfortunately, the risk of economic health being placed ahead of the literal health of citizens is a disappointing but inevitable outcome in many instances. When the economic stakes are so high, the show must go on, when perhaps it shouldn’t.

It is often written that the virus has imposed dramatic technological progress and engagement upon us all. The anticipated sedate adoption over  multiple years of home working, Zoom meetings, online consultations with doctors and to some degree  obsolete shopping centres and fully manned offices are just part of our ‘new normal’ when previously they would have been seen as radical jumps. While this is true, the immense polarisation this is creating is leading to a widening gulf between investment winners (Tech, Healthcare, Gold) and losers (to oversimplify, anything else). Having said that, we note that the rising tide has lifted even the losing boats, albeit not by as much.

Markets are knee-jerking to vaccine hopes although for the most part, cheaper, out of favour recovery stocks (‘Value style’) are facing ever greater risks. Zero sales revenue is a new scenario that few, if any, analysts had seriously modelled in recent times, threatening the financial viability of even some big, ‘grown-up’ companies.

This outcome has sadly hurt our portfolios given our long-term tilt to cheap stocks (based on long-term history and the merits thereof) and we have naturally had to make some difficult assessments and cut losses in places as we look to draw a line and adapt where it is the right thing to do.

With Government Bond rates now essentially pinned at zero across the developed world, money has fewer safe places to hide than ever, that is if you wish to receive a return at the same time.

Logically, Gold looks to be the next ‘safest’ place if Government bonds no longer offer a return. This probably explains much of the yellow metal’s ferocious rise year-to-date with related gold mining stocks rising at an even faster pace.

It is entirely possible that a ‘gold bubble’ could follow given the wall of money and long-term fundamental case for escaping debt-ridden fiat (Government-issued) paper currencies like Sterling, Dollar etc. over the decades ahead. That said, perhaps the gold market might have run a bit hot in the near-term and progress with a vaccine could certainly reverse the sentiment for ‘fear assets’. Nothing ever moves in a straight line.

Back in Britain, the authorities are desperately looking to stem the leaks from the bucket by plugging dozens of multi-billion pound holes with economic stimulus. It certainly seems far too early to worry that the bucket will overflow pushing up inflation. However, Brexit concerns are still afoot and the usual late night poker antics are surely inevitable at the negotiating table while the political stakes remain so high.

The FTSE 100 index continues to prop up the table of global stock indices given its multiple out-of-fashion characteristics and highlights the importance of having a global investment portfolio.

In conclusion, the risks of being very right or very wrong are higher than ever and we are unwilling to take big bets on the future market direction from here and instead are seeking appropriate ways to hedge against varying scenarios.

The details, views and opinions expressed above are KMD’s, can change at any time and are not intended to be advice or a solicitation to make an investment. Professional advice should be sought before acting on any information contained in this document. The value of investments can fall as well as rise and your capital is not guaranteed. Past performance is not a reliable indicator of future performance.