The Inflation Game…

As we noted in our recently issued 2021 performance update and 2022 outlook, we were expecting a turbulent first quarter this year. Although we are only in mid-January, markets have indeed brought some early volatility, so we thought it appropriate to drop an interim line to clients to reiterate our rationale and the opportunity set before us.

For some time now we have all been aware of rising inflation. Whilst inflation can have both positive and negative effects on investment markets, this depends on a number of different criteria. For example, good inflation is generally consumer led and is followed by increased corporate profits and rising wages. Bad inflation can be driven through supply chain issues, shortages in materials or distribution capability. There is certainly a lot of the latter in the current mix.

The reaction to rising inflation from central banks and governments is often to raise interest rates in an attempt to cool an economy that’s heating up. The problem for markets at the moment is their adjustment from expecting very little interest rate movements, to four or five increases in the US and two or three in the UK. This talk has spooked markets momentarily, and they have priced in these rate rises into forward valuations, driving volatility. We believe this repricing is completely overdone, and therefore is an overreaction. We were expecting (maybe hoping for this), though these things are always impossible to time.

So where do we go from here? Well, whilst we think there will be rate rises this year, we think there will be less than now expected, so we are holding course and buying into this sell off. We don’t see a buoyant UK economy going to the races in 2022 – for us the outlook is more sanguine. Rising prices combined with corporate and individual tax increases are not an environment that generally leads to a progressive economic picture. Inflation increases will slow into the spring and reduce later this year and into next. The fear of rapidly rising prices will subside. We believe markets will see this as the main game in town, sooner rather than later, reversing some of the pricing movements of recent weeks and providing an opportunity for those holding the right assets.

For higher risk clients we see this as an excellent opportunity to buy some great companies at discounted prices, and indeed for Low-risk clients, we are starting to see value coming back into the fixed income space, so whilst it’s a little painful in the short term, we think this short-term pain is going to be beneficial as we travel through 2022.

We built cash up in the portfolios as we took some profits from last year’s gains in November 2021, and we are now putting that to work as markets sell off. It is therefore time to be patient, and hopefully the rewards will not be too far around the corner. In the meantime, although valuations are a little under pressure, as always we are looking to be active to deliver on the opportunity set ahead of us.