24th June, 2022
Are we heading for a recession, and what does it mean for portfolios?
Regular readers of our blogs know that we like to communicate with our clients more when investment markets are difficult than when they are performing well. We know from feedback that frequent touch points are appreciated and from our perspective, it allows us to keep them updated with our views and the changes we are making.
Not only do we communicate more in times of stress, but our investment team are more active, working hard to reposition the portfolios for when things improve. In this respect, we are fortunate to have a well-resourced and experienced team, with all seven members focused on ensuring the portfolios perform strongly over the longer term.
This period of stress has been as hard to navigate as any we have experienced in the past. Equity markets are expected to have corrections in most 12 month periods, though one of the biggest challenges of the last one has been the performance of lower risk assets, which have also suffered inflation blues. The value of UK ‘risk-free assets’ for example (benchmarked by the Vanguard UK Government Bond Index), have fallen by more than 16% over the last 12 months. When you add in the losses we’ve seen in equity markets, it has left nowhere to hide.
Whilst it remains tough going, the team remain absolutely committed to getting the right outcome for clients. In trying to sense check our work, we look at our peers to assess their performance and our returns relative to what’s going on. We know the active changes to our portfolios this year have saved further drawdowns of around 2-3 % so far, and we have done this whilst adding to some areas that have continued to fall in value.
The chart below displays our Low to Medium Risk Portfolio as an example, though we have similar comparisons for all others, and although you will note the one-year performance to the 1st June is negative, comparative to our peers, we have performed competitively. In addition, we are confident that our commitment and experience in repositioning for the upside, (when it does materialise) will allow us to outperform meaningfully when things improve.
(The above performance is net of portfolio costs, though not all of DBW advice and product costs. Total costs are around 1.2-1.4% pa depending on the amount invested, the above costs are after deduction of around 0.55%pa of this cost)
When do we expect things to get better then?
We have been through the inflation story many times in recent blogs, and whilst it might have appeared obvious that it would have risen over the course of this year, this would likely have been a very short-term phenomenon absent of the war. To date we have had stickier inflation than we expected, and the response of central bankers to combat rising inflation has proved problematic for markets.
The next step in the narrative seems to centre on the possibility of a recession. If policy makers raise rates too much, markets fear they will force one as consumers are squeezed on debt repayments. If they do not raise them quickly enough, then inflation and rising living costs will have the same effect but potentially over a longer period. At this point they are damned if they do, damned if they don’t.
We do feel there is a significant chance of a recession here in the UK, in Europe and in the US. However, it’s important to not draw the conclusion that it would be a huge negative for investment markets. Recessionary environments reduce demand and inflation, and we have already seen big reductions in the price of Iron Ore, Copper and Lumber so far in June, perhaps starting to reflect falling demand.
In the UK and the US, our view remains that inflation will likely peak into late summer/early autumn, fall later this year, and will drop significantly into 2023. There are those that argue that it will stick around for much longer, and although we don’t think it will go back to the lows of the last two decades, we remain convinced it will normalise quickly as the economic data starts to worsen.
In that environment, fixed income portfolios will earn 4% to 5% per annum over the next 5 years without a sweat, and as we come out of recession, or if we just escape it, equity markets will pick up from their current lows, where we have seen the likes of Microsoft and Amazon’s stock prices drop 40% from where they were in January. In short, a mild recession to stop inflation is not an environment to be feared, and will be taken much more positively than persistently high inflation which could cause longer term problems.
So on that basis we see a mild recession (a near miss would be even better) as a positive catalyst for returns provided inflation comes down with the economy. On that basis we have revised our 5 year portfolio annual return targets upwards by 2% per annum for the next rolling five-year period. Again using Low to Medium Risk as an example, from this point forwards we are expecting 6% – 8% per annum instead of 4% – 6%. Optimistically, we don’t think clients will have to wait ages to see the benefits either, as a large portion of those returns could come through towards the end of this year and into 2023. Until then, we remain absolutely committed to working through these difficult times on your behalf.
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