When we go through a period of uncertainty we search for something we can be sure about. Certainty gives us comfort that we know what is likely to happen. There is a whole generation who have never experienced what we are seeing in 2022, whether it be a decline in stock markets, high inflation, or high interest rates. This adds an element of anxiety, and in this month’s update we want to share some of our thoughts on how we approach this when managing money.
In the quarterly update we mentioned a paper by Howard Marks called “The Illusion of Knowledge.” The premise of the paper is that economists are paid to predict the future but they are not that good at it. It makes sense when you consider that there are so many different variables that deliver the eventual outcome. When we think about the Brexit vote, Trump, the last UK election etc did we really know how people would vote?
2022 has been described as a year with many “1 in 100” events, whether it is the war in the Ukraine, global supply shortages, high inflation, high interest rates etc. What many want to know is when inflation will ease, when interest rates will stabilise and at what level, will Ukraine win the war, and what does all this mean for markets?
There are many fund managers who move money on a regular basis because they feel they need to do something, and in doing this they are implying that they know what is going to happen.
This quote is worth considering:
“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.”
Source: John Kenneth Galbraith
Each month we review our Investment Risk Matrix. This highlights the current risks and how we score them. The table shows a snapshot of areas we are considering:
|Russia / Ukraine||Red|
|Europe / Italy||Green|
|ESG / Sustainability||Amber|
|Lower Investment returns||Amber|
Let us consider “interest rates” as one aspect. This moved from amber to red in October so is at the highest level of risk. What are the thoughts behind this?
In the UK the pricing for fixed rate mortgages is at the highest level for 14 years. To put this into perspective, 12 months ago a five-year fixed rate was around 0.97%, and ten years 1.95%. Unlike the US most mortgages are on short term fixed rates and therefore as mortgages come to the end of their terms, people are facing significant hikes in payments. You could argue on its own it would not be a concern but when you consider the increase in fuel, food, council tax etc this means people have less disposable income.
With less disposable income people spend less and that will slow economic growth. There are also wider concerns about people’s ability to afford to buy and therefore you have a slowdown in the property market. Many experts are predicting house prices to fall by at least 10% next year and they might be right, but the facts as they stand are:
- Higher interest rates will have an impact on people’s disposable income, and this will slow economic growth
- There is evidence of a slowdown in the housing market because the costs are becoming unaffordable for many
What we don’t know is whether house prices will fall, and at what level interest rates settle.
When we consider investments in the short-term this will impact any asset which has interest rate sensitivity (property, debt etc). So what we have seen is a sell down in property, bonds etc.
Longer term, the path of interest rates is unknown. As investors we are considering investments over a 5-to-10-year period. Do we believe that property, bonds etc will not have a place in portfolios longer term? The answer is no, so although uncomfortable shorter term, longer term the story remains.
If interest rates settle at 3% to 4%, there are companies that will struggle more and therefore it makes sense to focus on quality. This could be a slight shift in where investors place their money. This is because you want to hold companies that have less debt, have a strong franchise, and can raise prices.
All of this leads to the question as to when a recession will come, and what does this mean for markets? The two tables below provide some food for thought. Markets have already come down a lot and therefore we could find that markets rise near the start of a recession.
The key is that a recession doesn’t necessarily mean negative returns, and equally in the year after a recession often we see positive returns. The other fact to consider is that the recovery in the markets often comes during the recession, and in some cases, this has been relatively early.
We currently have a recession as amber. This is because it is highly likely a recession will come but the impact is less known. If we consider the past, where the markets are etc, then logically we can argue that markets have already fallen a lot. This means that they must be close to the bottom. A recession might be positive for markets, and we could then start to see that recovery come through.
In summary, we are not forecasters, but we know the desire for some level of certainty. The investment risk matrix helps us consider risks and potentially longer-term implications on the portfolios. Can we say with a degree of certainty where rates will rest? No. Do we know what will happen with markets? Again, the answer is no. What we can do with markets is look at past events which should give us a degree of comfort that if the past provides repeatable patterns, then we should see a recovery and there is a chance that because of the declines we have seen this could be sooner than we expect.
Tracking the market
Bitcoin continues its decline and highlights the risk of chasing last years winner. Crude oil has dropped back but remains positive this year. The FTSE 100 has dropped into negative territory. The Hang Seng continues to decline but in the last 24 hours posted its largest one day gain since May 2009.
|1 January 2022||31 October 2022||Increase|
Sources of data: CNBC, Yahoo Finance & Reuters
What is in and what is out?
Eight of the top ten funds over the 12 months are energy based. The top three are iShares S&P 500 Energy Sector UCITS ETF +92.6%, Xtrackers MSCI USA Energy UCITS ETF +91.7% and iShares Oil & Gas Exploration & Production UCITS ETF +68.3%.
At the bottom is a mix of emerging markets, technology, and US. The bottom three are Schroder ISF Emerging Europe Fund -73.60%, HAN Global Online Retail UCITS ETF -72.0% and Nikko AM ARK Disruptive Innovation Fund -62.40%.
The most recent data from the Investment Association is up to the end of August. Areas seeing large outflows of assets included Europe ex UK -£489 million, Global -£756 million, North America -£373 million, UK All Companies -£772 million, and Short-Term Money -£319 million.
The areas which took the largest inflows included Global Equity Income +£101 million, £Strategic Bond +£288 million, Corporate Bond +£172 million, Mixed Bond +£205 million and Infrastructure +£205 million.
The chart below shows that net sales in the UK continue to be negative this year as investors remain nervous:
We continue to see energy investments do well this year and emerging markets, especially emerging Europe, struggle. Investors seem to be moving money from cash to bonds but more money is coming out of the markets than is coming in. When we look at the chart we can see that as markets went up investors added more money but as markets declined so investors withdrew money. It is always worth remembering the Warren Buffett quote, “be fearful when others are greedy and greedy when others are fearful”. It does feel we are at that fearful stage.
We cannot say when markets will recover but investors are starting to capitulate seeing no light at the end of the tunnel. The charts below are helpful reminders about staying invested and the dangers of trying to time the markets.
Sources of data: TrustNet, Investment Association, Putnam
Talking shop with fund managers
We have met 23 managers over the last couple of months. Below is a random selection of thoughts:
- The fed wants to crash the market and stamp its credibility of being independent
- Recessionary risk has risen in the last couple of months to 75% chance
- Business confidence in the US has fallen into recessionary territory
- S&P is still above the average drawdown so expecting it to come down further before going up
- Momentum for returns is coming from real world assets and much of this comes from smaller emerging markets and not China and India
- Thoughts that UK could be lucky and have a shallow recession, but expect zombie companies to be cleared out with a greater number of defaults within the equity and bond markets
- Expect a return to boom and bust cycles
- Companies which have led us over the last ten years will not the ones which lead us out of this environment
- Consider Japan which is a liberal democracy, the rule of law prevails and there is a stable political environment
- Climate change is a risk to global economic structures. Those companies that succeed are those that can adopt to change
General disclaimer: The data has been sourced from external sources and although we have looked to ensure this is as accurate as possible, we are not responsible for data they supply. The view on markets is written in a personal capacity and reflects the view of the author, it does not necessarily reflect the views of LWM Consultants. Equally the views under talking shop are those of individual fund managers. Individuals wishing to buy any product or service because of this blog must seek advice or carry out their own research before making any decision. The author will not be held liable for decisions made because of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.