We highlighted in our January commentary that the likelihood of rising interest rates and withdrawal of liquidity could lead to volatility in financial markets. We did not expect this warning to be a significant understatement as the Russian invasion of Ukraine and ensuing cost of living crisis added to economic woes. China also contributed to negative sentiment by maintaining a zero Covid policy, thus exacerbating global supply chain problems.
Investors have therefore had to cope with a changing scenario in which Central Banks were considered at first to be too complacent about booming economies and rising inflation and now are considered hell-bent on inducing a recession to calm things down. Consequently, as of late May, the more technology orientated US indices had shed over 25% of their value, the UK Government Gilt had produced a loss of circa 10% whilst the oil price had soared 45%.
The word ‘recession’ is emotive and many people automatically associate it with a 1930’s style depression. We certainly don’t think that is on the cards as simply there are not enough signs of excess in the real economy. Both household and company balance sheets are in decent shape and the latter, in general, are not swamped by excess inventories.
Indeed, this is likely to be a slowdown unlike most others as there is still significant pent up demand for holidays, dining out and indeed the gamut of social activities. In Europe and, especially in the UK, capital expenditures could even be considered subdued rather than excessive, so there is significant evidence to suggest that any slowdown will be contained and relatively short lived compared to history. Especially as China and much of Asia are at, or very close to, the end of their policy tightening cycles.
At WH Ireland we like to talk about the Big Picture and indeed view it as our job to take in the Big Picture and not be buffeted by short term volatility.
Doing so at the moment allows us to take advantage of significant price moves. For example, the chart below highlights that despite press hysteria US Core Inflation is showing signs of peaking.
So, with yields on 10 Year US Government Bonds having increased from just over 1.25% to just under 3% we have taken the opportunity to invest in such for the first time in a long while. We are still underweight and will only add more if yields rise further.
All year we have been wary of investments based on hope rather than real cash flows and this has helped us escape the worst of the selloff.
We are now systematically and gradually using the selloff to invest at lower prices.
The Bigger Picture suggests the real world will get through this period of very high inflation and that financial market volatility is producing valuations from which historically there is a high probability of generating positive returns, as illustrated in the chart below.
