August Performance Update

Please note: due to the events of last week, this blog was originally due for release on Friday 9^th September and was written preceding the passing of Her Majesty the Queen. We are joined with the rest of the nation in mourning, inspired by her values, achievements and longevity.

We started the new month with a new Prime Minister, as Liz Truss walked into Downing Street bright eyed but no doubt aware of the challenges that await her. She is the UK’s 5^th Prime minister in the last 12 years. One of my colleagues claimed that to be a low turnover given that Nottingham Forest have had 21 football managers over the same period… maybe we should be thankful?! High turnover, is of course, a sign of instability, and for the UK political and economic arenas, that certainly seems the case currently.

The reality of the job ahead for Truss is that she faces significant challenges – to find a way to navigate the UK economy through one of the most difficult economic environments in decades.

Top of the agenda is the forthcoming winter energy crisis, which without support is likely to push UK inflation from the 10.1% printed in August, to somewhere between 13% and 16% by the time we get to the spring. That would cause too many issues, and so it is not surprising that her immediate reaction has been to table policy that would effectively “cap” energy prices around current levels.

This is an important development. Markets are fearful of rising inflation, and a tightening of monetary policy (increasing rather than reducing interest rates). Up to now, both Central Banks and Governments worldwide have talked the hard game about the need for tighter policy to tame inflation. Changing the mantra to provide financial support once again as Truss is suggesting, should start to underpin confidence. That should translate all the way from people to markets, especially if the rest of Europe follows a similar tact which seems likely if the Covid co-ordination is anything to go by. This time the financial help will be to meet energy bills for both families and businesses. The cost will be huge, (early estimates are over £100 billion), though it should help stem the effects of inflation and possibly protect the UK from what, at the time of writing, looks like a nailed-on recession.

Outside of that, August was another challenging month for both equities and bonds, as some of the summer optimism dissipated. Economic data out of the US remained quite positive. Inflationary pressures continue to show signs of abating (unlike in the UK and Europe), and jobs market data continued to be more resilient than expected. We saw a summer rally to start the month, with our portfolios gaining around 5% from 20^th June to mid-August. The reaction of the US Federal Reserve however was to reiterate that despite falling inflationary trends they were going to press home with further rate rises, to ensure they fully defeat the inflation beast. Markets didn’t react well, and as such the positivity abated. It was a case of good economic news is bad news for markets. Untangle that one if you can!

From a portfolio perspective, our regular readers will know that we always felt a summer rally was likely, but that it would not be the start of a sustainable run just yet. We therefore used the market rally to take profits on positions we had entered and built cash levels. Since 19^th August we have increased our cash position to between 5% and 8% across the portfolio range, which gives us further opportunity to re-add when key markets hit our trigger points.

The August sell-off was particularly dramatic in the fixed income market. Fixed income is a core asset for lower risk portfolios, so although we had reduced our weightings, the portfolios were not immune from the late August slide. To provide some context, since the start of the year UK Government Bonds have lost more than 20% of their value.

All that said, at the time of writing high quality bonds are now providing income returns of around 5% per annum, so the opportunity from here remains excellent over the longer term. It is an opportunity of a similar size to that we saw in the Great Financial Crisis of 2008, and we have been progressively adding across the year so far, with further opportunities given our cash levels.

All-encompassing, the long-term opportunity set remains extremely attractive from here, though the path to get there remains data dependent. There is a significant return opportunity down the line, though it remains difficult to see where this begins in the next few months. When it does arrive of course, returns generally accumulate quickly, just like during the July and early August rally, noted in the graph below, where we’ve used our Low to Medium Portfolio as an example, and compared it to a consistent panel of peers. It is of course pleasing to see it performing well on both the upside and downside relative to the competition, though most importantly, it provides validation that once data becomes more supportive, we should be well positioned to benefit.

As always then, patience is a virtue, and we think it will lead to significant returns on a five-year view from here. The income yield across our portfolio rate is now in excess of 3% per annum, and the capital upside potential looks compelling by historic standards. Unfortunately for politicians and football managers, they are not often afforded the time to deliver. History generally shows that those that are tend to drive the best outcomes.