DB Wood Team
4th February, 2022
Blog, IC Insights
January Performance Update…
Warren Buffet once wrote “a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses”.
It may seem like a simple statement, but its often the simple things that we forget in periods of volatility. Investment markets are, after all, an aggregation of all our feelings and expectations, and it is human nature to overreact to the short-term.
January has been a tough month for all investment markets, ironically the much-maligned FTSE 100 index in the UK being one of the few markets to have performed well in the month (+1.12%). This gain was essentially on the back of the rise in energy prices and the forecast for future interest rate rises, which suits the index as it is dominated by banks, and oil/mining companies. We have a small exposure to this market, and on a forward view we are not supportive of its current core sectors, or the environment that would mean they might continue to prosper.
What has driven market movements in January is really what we referred to in our blog a few weeks ago, which you can find here. It is our view that markets have overreacted to recent news about inflation and interest rates. We have seen a considerable correction across many areas, suddenly attaching much more attractive valuations to the solid businesses Mr Buffet describes.
Our base case is that the upward trend for inflation peaks in the near term and reduces into the 2nd part of the year, easing the pressure on Central Banks and providing markets with the reassurance that interest rates will not need to go up 5 times this year, which is what is currently baked into US equity markets, with the UK not far behind. Our view isn’t to say there won’t be pockets of price increases or some interest rate rises. We expect the Bank of England and the US Federal Reserve to increase rates in Q1, and possibly in Q2, though after that we think inflation pressures will reduce and the data will not require further short-term rate rises to the extent markets currently fear. If we are to be wrong, we’d have to see significant increases in wage growth and commodity prices, alongside and more supply disruption. If anything, we see the supply side easing, and given the consumer in the UK faces tax rises from April, we don’t see our consumer led economy going to the races anytime soon.
The other major cause of market concern is the Russia-Ukraine tensions. It is very hard to predict the direction of travel here, though it is potentially bad news if things escalate further. We still feel that an invasion is unlikely, but we do hold assets that would do well in the case of black swan events, such as a reasonable exposure to US treasuries. The challenge is that US treasuries don’t like inflation, and markets are viewing inflation as the greater threat at the time of writing. January was therefore a month where our safe havens didn’t provide any protection from falling prices elsewhere.
However, its normal to have months like these. Just as we did recently in November 2018 and in March 2020 our investment team have used this period as an opportunity to add to holdings that have become cheap. This is harder to do than it might appear, though we have an experienced team and disciplined process to help guide us. There are parts of the market that are down nearly 50% since the start of the year, with no real change in fundamentals. Netflix is a prime example, which has lost 30% in the last four weeks despite reporting record growth and earnings. Even if we are slightly out on our inflation or interest rate forecasts, these price levels provide us with great confidence that this is therefore an excellent opportunity on a 5-year view.
In January our portfolios are down between 1.8% (Very Low Risk) and 8% (High Risk). To put some perspective on this, despite the months fall in valuation, the same portfolios are up by between 9.78% (Very Low) and 25.58% (High) in the 3 years to 31/01/22, well above benchmarks.
From a client perspective we always come back to investing patiently over a sensible timeframe. If you are accumulating, then we believe January has provided an excellent base from which to build your portfolio. If you are drawing on your portfolio for income, then you are likely to hold a lower risk investment mix. For ‘dynamic planning’ clients specifically, we generally recommend holding 3 years of income in our Very Low Risk portfolio, which remains very flat over the short term, providing a solid base in periods of volatility. Ironically the excellent returns we have made in the last three years were built on market falls in Q4 2018 and Q1 2020. We feel Q1 2022 is another such building block.
Whatever your situation, your planning team will have agreed an investment strategy appropriate to your objectives. This should provide confidence that the short-term numbers matter much less than the long term. Given the discount we are now seeing in quality businesses, we are even more confident that we will achieve the latter, and as Mr Buffet alludes to, it pays to be patient and watch that play out.