10th June, 2022
May Performance Update – Patience will be Rewarded
2022 has been a year of two variables; inflation and interest rates. The performance of all asset classes over the last five months can be almost wholly attributed to these variables, which started rising early in the year and were exacerbated by the war in Ukraine and the Chinese Covid lockdowns. Thankfully though, there is a silver lining, and it’s a big one…
To first discuss May, it was a month of two halves for investment markets, where early losses were all but erased by a flutter of positivity at month end. The US inflation rate fell (albeit not by much) for the first month in 7 months, and China started to ease its regional lockdowns, both of which were seen as small but needed positives. The general market narrative has shifted to “bad news for the economy is good news” – the idea being that slowing economies will lead to falling inflation and in turn more accommodative policymakers. It sounds a bit counterintuitive, but the best forward environment for markets is one where the demand for goods and services cools, and there seems a real possibility of that given general confidence both in Europe and in the US.
On the other side of the equation, the oil price continues to move frustratingly higher, which has an almost immediate inflationary impact through petrol pump prices. We really need to see some stabilisation in energy prices to help inflation start to fall meaningfully, though with a quick resolution in Ukraine seeming a distant dream, this feels unlikely at the current time.
We therefore enter June with markets poised awaiting further news. Once we see further downside in the inflation numbers, alongside some slowing economic data, then we expect a significant improvement both in bond and equity markets. Until then investors are likely to remain cautious. We have spent the year repositioning our portfolios as value has emerged, to benefit when things improve. As frustrating as it is, we have to remain patient. We know the opportunity is coming, though it may take a little while yet to get there. That said, our central case is that we are somewhere close to the bottom of the current trend.
We’ve discussed in recent blogs the reprice we’ve seen across a number of assets. Fixed income as a prime example is now yielding circa. 2% more per annum than it was just at the start of the year. This will stand us in good stead if economies head towards recession, as we would expect a flight to safety with yields moving lower and bond prices rising. Equities on the other hand are already pricing in a depressed outlook and are therefore unlikely to fall significantly further even if the economic environment deteriorates. If we don’t get a recession, our equity holdings should perform positively, and we will still pick up a decent yield from fixed income. So as we sit today our portfolios feel well positioned for a variety of forward scenarios, having added to both core asset classes at excellent valuations.
Onto that silver lining… given the above, it’s worth highlighting how markets have performed historically following similar valuation resets. In that respect if you stay the course, the benefits that follow over the following 12 to 24 months can be significant.
The chart below highlights past outcomes, comparing the calendar year returns for our Low to Medium Portfolio (though the same trends apply to all risk profiles) since 2010, with the biggest intra-year decline i.e. the worst point in each calendar year.
Using 2011 as an example, at the worst point in that year our Low to Medium portfolio was down 7.93%, though by the end of 2011 it had recovered 6% of that loss, and the corresponding year it added another 8.89%. In other words, between the worst point and the end of the year after, it had returned 14.88%.
2018 is another great example, with the market correction coming in Q4 and bottoming the day before Christmas eve. Although only 1.36% was recovered by year end, that was followed by a 10.59% return in 2019, so from the worst point in 2018, our Low to Medium Portfolio added 11.95%.
There are of course other similar examples on the chart, not least 2020, which saw the biggest reversal and upside of them all (a 24.55% return from the worst point in the covid crash). Importantly though, all shared two things in common. Market downside in the first instance due to a significant macroeconomic risk, but an even greater recovery as the risks receded.
As hard as it is in practice, history suggests patience in investing really is a virtue. The benefit of an active and liquid portfolio is we can reposition to the areas we perceive offer the best risk reward combination from here. Our team are working very hard on this objective.
(Please note returns are quoted gross of advice and platform fees of between 0.7%- 0.9%pa depending on the amount invested).