Log inMarket Update from Jilly Mann – 22nd August 2022
Market Update – “what can we do, we’ve got to get on with the job”
As the UK wakes up to Felixstowe dockers striking for eight days, ongoing transport strikes and the rise of the Unions again, echoes of the early 1970s ring louder. We commented in our last update that one challenge for policymakers today is a lack of working experience of managing comparable inflation and interest rate rises such as was experienced in the 1970s. Yet a return to the economic trials and tribulations of the 1970s remains the priority outcome to avoid for contemporary politicians and economists.
In this update, we will summarise amongst other things, where we think the economy is heading, what this means for markets and how putting the cart before the horse remains a major risk for investors today.
- Bear market rally or the roots of a bull market?
- Avoiding the froth
- Interest rate rises and the cost of living crisis
- The impact of productivity on the UK economy
- UK Property market – should we be worried?
- Conclusion
With that in mind, if you are able to watch this video from 1974, reproduced via the BBC archives, I would recommend it to you: https://fb.watch/f0zvvUBbW7/ The North East may seem a long way from Northants geographically, politically and economically, but this report highlights the stoicism of the people, their fears over energy supplies, the impact of wage reduction, a reversal in economic fortunes from optimistic investment to anxiety over continued investment and the resolute spirit that was required to keep going and see both sides of the argument. It isn’t hard to draw parallels in any of those points to 2022, especially on the back of the Government’s recent Levelling Up campaign and the “Red Wall” electorate.
I confess to a personal interest in this story as my late grandfather concludes the film, but I believe memories of the 1970s are the reason why Governments will be forced to intervene whether they want to or not and why the current resurgence in public sector strikes will split the people just as it did before, at a time when there is no easy solution to be found.
Bear market rally or the roots of a bull market?
Since our last update, I have updated the above chart, which displays the performance of major global markets alongside the Telford Mann Score 4 Moderate growth strategy (orange line) since the start of 2022. Markets remain disparate. The FTSE All Share (lilac line) is just about keeping its head in positive territory, whilst the Nasdaq 100 (navy line) remains down by 16.79% year to date with the S&P 500 (brown line) down 10.66% year to date. The Nasdaq 100 and S&P 500 represent the US market in terms of technology and broader industry.
Our score 4 Moderate (growth) strategy is down just over 3% year to date, but we remain pleased with the consistently steady improvement in returns which the strategy is producing in what remains an uncertain market. If we had plotted the Telford Mann Score 4 Moderate (income) strategy as well, you would see a similar trajectory, but with a positive return year to date of just over 1%. As we always say, our goal is a positive return year in, year out for all investors, but I am pleased that year to date we are seemingly managing to avoid much of the hype in markets, whilst still participating in rallies when they happen.
I mentioned earlier that we need to avoid putting the cart before the horse and this is in relation to the question of whether or not we are in a bear market rally or if we have entered the early stages of a bull market.
No economist can categorically answer this question with certainty. The positive signs are that in hindsight, we do seem to have reached the bottom of the market in mid-June 2022. The chart above indicates that markets haven’t retrenched to that level since mid-June and seem determined, based on current data, to stay above that marker. As ever, there is always a caveat to this point, as an example Russia may retaliate to the bomb attack on Alexander Dugin’s daughter after accusing Ukraine for her death. Mr Dugin being an ally of Vladimir Putin. That incident may prompt further concerns over European security and energy prices that permeates markets, but based on what we know so far, markets seem to have found the bottom and don’t want to fall further than that.
So does that mean we are now in a bull market? Not necessarily. Just because markets don’t want to hit that low again, doesn’t mean that they can’t go down. They will just be unlikely to go down as low.
The end of July through to the start of August 2022 was a particularly profligate time for certain global markets such as the Nasdaq 100 and S&P 500. We were seeing consecutive days of positive returns, weeks of the highest returns seen in markets for months and commentators were starting to call the end of the bear market and the start of the bull market.
In our view, we still remain in bear market rally territory. Looking back, we saw in the recovery from the 2008 Global Financial Crisis that amidst the optimism, there were many false dawns. As the economic cycle extends, bear market rallies can last for longer and be more confusing. The longer they last, the easier it is to believe that the bear is behind us. We may be wrong on this, only time will tell, but we believe that we remain in bear market rally territory, albeit with some encouraging signs for a global recovery starting to come through. We have therefore, decided to maintain our defensive stance on portfolios. Whilst those defensive strategies continue to reap rewards and whilst we remain concerned about global inflation, politics and trade, we do not feel comfortable in rotating the strategies into anything more bullish at this time.
Avoiding the froth
The graph below compares two US stocks; Docusign Inc and Microsoft Corp. Both US technology stocks. Some of our readers may be familiar with Docusign, as they produce e-signature technology which replaces the need for paper-based signatures and is increasingly used in business.
Docusign is the black line and Microsoft is in purple. The graph runs from the 1st July 2022, a period during which many were calling for the start of a bull market. This chart highlights what we mean by avoiding putting the cart before the horse. Microsoft is currently trading higher than Docusign, but if you look at what has happened to both stocks since the 1st July 2022, Docusign grew to a high of 24% up, much more than Microsoft, whose peak was around 13%. On the downside, they both suffered similar downturns when markets dipped in late July. From trough to peak, Docusign returned around 26%, but it has given back those gains to Microsoft which has been a lot less volatile, hence why Microsoft is presently trading higher than Docusign.
This sums up our approach. The headline excitement would be to back Docusign and pocket those 26% returns on the good weeks, but we would then be exposing investors to handing back those gains as quickly as we found them. Microsoft is less exciting and with potentially less in the way of short-term highs, but it is a more stable stock long term and maintains market share with a competitive advantage over its peers.
This is not to say that Docusign won’t still exist and flourish in years to come, but it is to say that we don’t think it is the right stock for this market.
The UK and global markets are still littered with too many stocks that sadly need to fall by the wayside. The desperate bulls may win out in the short term and keep them afloat with optimism over a bull market dawn, but with supply chain challenges, rising interest rates, productivity concerns and uplifted inflation, any market announcement which isn’t entirely supportive of their fragile existence causes major market movements downwards.
Bear market rallies won’t exist forever. At some point we will enter a bull market, but for now we firmly believe that there are more reasons to be conservative with our portfolio positioning than to chase more exciting returns and expose investors to the likelihood of such a swift reversal in fortunes.
Interest rate rises and the cost of living crisis
Global inflation has remained high. In the UK, the level is now above 10%. In the US, certain sectors are starting to see inflation fall, such as the used car market, but it is remaining stubbornly high in sticky sectors such as healthcare and residential rents. We have reported before that with inflation typically reported on a 12 month rolling cycle, sectors which have seen a super-spike based on extraordinary factors such as used cars will then report rapidly falling inflation numbers when the extraordinary circumstances pass. Only so many people will be looking to replace their car and supply chains delays will slowly unwind, making new car purchases more attractive again.
The Federal Reserve have been explicit of late in trying to bring some realism to investment markets. The US is starting to see unemployment numbers rise, not generally a good thing for the people, but a necessary factor for inflation to fall. Less people in work should lead to less demand as discretionary spending reduces, so inflation should start to fall naturally. That said, the overall inflation rate is way above the target rate of inflation and the Federal Reserve have gone to great pains lately to confirm that they intend to continue raising interest rates until inflation is under control. It is not under control by any stretch as it stands.
The market has been ignoring the Federal Reserve and has instead been reacting to data such as unemployment figures by forcing these bear market rallies which I alluded to earlier. Undoubtedly, the Federal Reserve was late to raise interest rates in the first place, but it would be a major surprise if they suddenly changed course and didn’t continue to raise interest rates through to the end of the year. They may slow the rate of increase, but if they don’t follow through on their announcements, the Federal Reserve will lose all credibility as a forward signal for the economy and so it is reasonable to expect more interest rate rises until the controllable inflation factors are indeed under control.
By controllable, the major inflationary factor that is out of control is energy prices. Energy prices have started to come down a little in the US and across the board gas prices have fallen from their all-time highs, but with renewed tensions between Russia and Crimea expected and China remaining something of an onlooker rather than participant at the global economic table, there are reasons to believe that energy price inflation will remain extremely high and that commodity prices may rally from here for a period through the remainder of 2022. This is an opportunity we are currently reviewing in our portfolios.
In the UK, the energy price cap is all consuming. There are two facets to it. Firstly, the impact on individuals. Energy bills are soaring, the next price cap is likely to rise further and without intervention is mooted to reach untenable levels in the Spring of 2023. Secondly, the impact on business, where there is no price cap on corporate energy bills.
Reverting back to the video I mentioned at the start of this piece, it was lighter engineering companies who were seemingly hit hardest by the three-day week and the lack of energy supply due to the miners’ strike. Fast forward to 2022 and the Felixstowe port strike. Felixstowe as a port doesn’t operate on a “just in time” basis and so that means that goods transiting through the port can take longer to reach their destination without crippling supply chains. The port itself may lose custom if the strike extends beyond 8 days, but the immediate term issue for the port company isn’t so threatening.
The losers from the dockers strike are those companies depending on trade transiting the port for their own business flows. Haulage companies are a good example. An industry already fending off rising fuel bills and now seeing their daily custom evaporate as there are no goods to collect or deliver. Wages still need to be paid, but there are no invoices to issue for goods transported. In this context, the dockers strike isn’t so different to 1974, where private sector industrial and engineering companies are caught in the middle of the standoff.
The impact of productivity on the UK economy
The UK is in a different position to the US in that employment is still extremely high due to a lack of personnel to fill jobs. Liz Truss has come under fire for her comments regarding the productivity of the UK workforce this week, but there can be few people trying to recruit at the moment, not finding it increasingly difficult to fill those roles or find the right calibre of individual. Whether her comments are right or wrong, the productivity of the UK economy is falling and this is leading to real concerns over the threat of a prolonged recession.
Ironically, the threat of a recession may precipitate a recovery in productivity in the UK market. Workers concerned about the threat of potential redundancies are thus starting to make a return to working from the office in effort to remind bosses of their qualities. This is a reversal of the current trend for working from home, the pervasive nature of which is something which I personally believe will come to be looked at as a negative factor for the economic recovery in years to come.
It is fair to say that in the same way it took years to work through the fallout of the Global Financial Crisis of 2008, the same will be true as the globe recovers from the Covid pandemic recovery effort. It was only this weekend that the European Union ended its “enhanced surveillance” program on the Greek economy after Greece received three successive bailouts in 2010 to prevent it from being removed from the Euro single currency group. Recoveries take time and are bespoke to markets and circumstances.
We are facing a period where new challenges will continue to emerge month on month, but this is also now a time where investing into markets that we have a transparent view on, and which are based on real assets, is the greatest certainty we can deliver for portfolios.
With that in mind, three of the funds we introduced to portfolios in mid-July 2022 have all contributed extremely positively to performance and all deliver that transparency we seek on currency exposure, geographical weightings and underlying holdings:
The JPM Global Equity Income fund (purple line) is up over 9.4%, the JO Hambro Global Opportunities fund (turquoise line) is up over 8.5% and the L&G Emerging Markets Local Currency Index fund (yellow line) is up nearly 4% since mid-July. Uncertainty can still bring opportunity.
UK Property market – should we be worried?
The UK property market is often seen as a symbol of the strength of the UK economy. As a nation we have a sometimes unhealthy obsession with house prices.
The property market is split in two, commercial and residential.
In terms of residential, anecdotally the threat to UK house prices lies less in interest rate rises and more in energy price rises. A whole generation of homeowners have benefitted from cheap credit and low to zero interest rates. With interest rates rising that could spell a threat to mortgage repayments. Property insiders though aren’t citing interest rates as the biggest threat to the property market with many people currently locked into fixed rates at low levels. The biggest issue appears to be overall household spending and whether or not people can afford to pay the bills with fuel prices doubling, electricity and gas prices soaring and food price inflation providing a triple whammy on the UK household. If anything sparks a property market slowdown, which I think has already started, or even then signals a sustained fall in UK house prices, it will be the overall cost of living crisis rather than interest rates.
Until a new Prime Minister is in situ and delivers their plan to deal with this cost of living crisis, very little will change. Both Rishi Sunak and Liz Truss have tweaked their original proposals for easing household pressures and it remains to be seen what actual measures will be introduced. We have warned before about kicking the can down the road and delaying addressing inflation head on, whilst instead delivering a short term feel good factor that keeps inflation bubbling under the surface. Whoever is elected Prime Minister, it seems we are going to get more short-term measures. Whether the new Prime Minister can avert the political demise which came about for the ruling parties in the 1970s where the sitting Governments were overthrown on two occasions by striking workers over rising inflation and wage demands remains to be seen, but something needs to happen sooner rather than later to stymie the increasing divide between the public and private sectors. One senses that after the Summer holidays, the impact of strikes will become ever more impactful on anyone going about their daily business. Exactly what the Unions may want, but likely to lead to increased tensions as a result.
Commercial property continues to be a positive contributor to our portfolios and whilst 2022 has seen less activity and more of a wait and see approach to the completion of certain deals, demand continues to outweigh supply. Buyers are typically multinational logistics firms whose business models are largely insulated from the vagaries of the day to day economy.
A protracted recession is still highly possible in the UK and we expect interest rates to keep rising, but this doesn’t have to equal a significant fall in stock markets.
Markets do move in a cycle and to give an example of our current positioning, we own plenty of assets in the infrastructure sector. The L&G Global Infrastructure Index fund is up over 17% year to date. We currently own very little in the UK Smaller Companies sector.
Towards the start of the pandemic in mid-2020 we bought heavily into the UK Smaller Companies sector (black line) and we did very well from the allocation, but we sold out of this sector in 2021 when we felt that the market was turning. There will come a point at which UK Smaller Companies will be attractive to us again, but with our concerns over the UK economy, the political outlook and rising energy prices, we think the upturn experienced in UK Smaller Companies in July 2022 has been a bear market rally and is likely to recede. We keep in mind the concerns we have over those lighter engineering companies we referenced earlier, many of whom are examples of UK Smaller Companies. The infrastructure sector (blue line) has largely trended upwards in a much less extreme way relative to UK Smaller Companies. At some point infrastructure assets will lose value and we will sell down from them, but for now this is some of the logic which goes into our investment decisions.
Conclusion
I know many of our investors have been concerned about economic news of late and we should all be concerned about the reports we have heard, but it is important to differentiate the broader news from our portfolio positioning. On balance, this may be a time when we could be late into a bull market and miss out on a few percentage points at the start of a rally if suddenly sentiment and global conditions shift dramatically, but that is a stance we are willing to take, because we feel that the risk of being too early into markets at the moment is far greater than the risk of being cautious.
As we head into late Summer, we are keenly looking for signs of optimism. We are actively reviewing our European allocation and our commodity exposure. The bond market hasn’t yet given any signs of a change in policy or sentiment, but the bond market will be an early indicator that market conditions are changing and it is likely at that point that we will increase our allocation to fixed interest and a mixture of growth orientated equity names. If conditions persist as they are, or indeed worsen, we will continue to top up on names that have contributed strongly to portfolios such as the equity income funds, global opportunity assets and infrastructure names. If that happens then we may also find opportunities in “value” names, also regarded as the survivors in a prolonged bear market.
This is to say that whilst we are cautious about the newsflow, opportunities remain for investors. We aren’t putting any carts before the horses by getting excited at any single piece of economic data, we expect Governments to act before the lights go out and any repeat of the 1974 three day working week should be enough of a threat to force compromise with the Unions. There is no point us pretending that any of those issues aren’t real, but portfolios are recovering steadily and whilst we all want a recovery to be faster and higher, that isn’t the market we are in right now. To our minds, a fast and high recovery right now equals a faster, lower fall swiftly after.
All things being equal, we remain patient and hopeful that 2022 continues to see this steady upward trend in portfolios. As the shopkeeper in the video said, “what can we do, we’ve got to get on with the job”.