April Monthly Note
The UK economy grew at a blistering pace in 2021 despite the impact of Omicron. GDP grew by 7.5% for the year, marking the strongest growth since 1940 and the second world war. Growth was aided by the fact that output declined by less than expected in December, with economists expecting a large drop as some coronavirus restrictions were maintained, hitting the retail and hospitality sectors.
The war in Ukraine continues to send shockwaves through global economies. Inflation was already rearing its head, but the war has exacerbated supply issues with some commodities, which are recording strong returns this year, and causing heavy disruption to the global energy markets, particularly in Europe which is heavily reliant on Russian energy. Inflation in the US, UK and across Europe now reading higher than anytime for several decades and showing no signs of abating. We’re seeing mixed signals from traders in different markets, though, as the US bond markets are pricing in Fed interest rate hikes all the way into next year, however here in the UK traders are expecting the Bank of England to start cutting rates next year as high inflation and the cost-of-living crisis starts to hit economic growth.
In China there were more positive remarks from the government, which pledged to support domestic equity markets after recent government crackdowns have hit valuations and sent Chinese stocks plummeting against other markets, particularly the US. The central bank is also more accommodative than its western counterparts, which makes for some potentially interesting monetary policy divergence on the horizon.
The macro backdrop remains supportive for risk assets, albeit there are more risks emerging. Equities will continue to benefit from further expanding global economic growth and higher earnings. Some value equities offer more immediate upside over their growth peers, as they tend to benefit most from strong recoveries after recession. We are taking a more cautious approach to portfolio positioning for a possible resurgence in inflation. We still like selective growth stocks where there remains true innovation and potential for change, especially recent trends in consumer behaviour being driven by the pandemic. Fixed income remains unattractive given record low (and negative) real yields and the thin spread between sovereigns and corporates offering little in the way of reward for risk. Bonds remain an important diversifier in our portfolios, but given current yields the return profile looks unappealing, with downside risk in long-dated government bonds extremely elevated given the outlook for interest rates and recent commentary from major investment banks regarding monetary tightening. Low duration bonds therefore look the more appealing investment, along with inflation-linked bonds which offer some protection to rising inflation. We also hold an allocation to cash to offset some of this fixed income risk.
We expect the UK to continue to recover well from the pandemic as the widely successful vaccine rollout and ending of pandemic restrictions in England boosts economic activity. The UK has some of the highest forecasted GDP growth in the world which should feed through to corporate profits which we expect to rise. Valuations in the UK remain extremely attractive given the outlook for the economy.
There is good value to be found in European equities, particularly after the Russia-Ukraine was hit equities more recently. Earnings growth has been strong during this period, as has stock market performance, and with the ECB so far behind the inflation curve there represents good opportunities in selective European value shares.
The US represents poorer value relative to the rest of the world due to the high proportion of tech companies that currently command a multiple far in excess of the broader market, however it also has the best long-term earnings growth and some of the most outstanding quality companies, as well as the most innovative. In times of global stress, the US also tends to act as a safe haven investment, which props up markets. We believe the US will remain an attractive investment option, but with some obvious headwinds making us more cautious. President Biden has made no secret of his desire to increase tax rates, and the Federal Reserve have been clear they will not be getting any more accommodative.
We believe Japan to be an extremely poor environment for equity performance. The Japanese economy is predicted to grow at the slowest pace of all regions, in addition with a declining and ageing population, the prospect of future economic expansion looks unlikely. Thus, we expect poor equity performance from Japan.
Asia Pacific and Emerging Markets are predicted to see exceptionally strong GDP growth over the next year, but are struggling with the pandemic, particularly those countries who are not so able to distribute vaccinations to their populations. We remain concerned at the decreasing Chinese stimulus, together with regulatory crackdowns, investments in China require careful monitoring. However, the recent selloff in Chinese markets looks overdone given the longer-term outlook for the economy, and we remain positive on the emerging markets growth story in the long-term, and thus are comfortable maintaining an overweight position. The more recent positive remarks from the Chinese government is positive, but must be taken with a pinch of salt. We currently like frontier markets as a more attractive investment option within the emerging markets universe.
The opinions expressed in this update are those of A&J Wealth Management Limited only, as at 4th April 2022, and are subject to change.
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