February 2022 Monthly Note
As Boris Johnson struggles to regain control of his premiership following revelations about private parties held at his Downing Street residence during the depths of the country’s lockdown, the rise in national insurance is said to be going ahead as previously planned. Many across parliament had hoped the measures would be scrapped as the economy reels from higher inflation and potentially slowing growth, however the government confirmed NI will increase by 1.25 pence in the pound from April. The government is also bringing forward a new “Brexit Freedoms” bill, which aims to make it easier to shed EU regulations post-Brexit. This could cut red tape costs by £1bn, and will likely benefit the City most, as the UK looks to diverge from EU regulations having failed to be granted equivalence by EU regulators.
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Inflation is still a problem for central banks, with some now forecasting the Federal Reserve to raise rates five times in 2022 and the Goldman Sachs now predicting the Bank of England will do three hikes this year. The Fed is due to begin balance sheet runoff (letting bonds mature without selling them into the secondary market first), which scared global markets into correction territory. Whilst inflation is not expected to go much higher from here, there is much debate as to whether we will see inflation at or above central bank targets, or fall back below, and what policies will be pursued to address this.
The Russia-Ukraine crisis continues, pushing up oil costs to over $90 p/b and flaming tensions between Russia and the West. The UK and others have threatened Russia with sanctions should it make any attempt to invade Ukraine, with the UK potentially targeting rich Russian Oligarchs who own property in the capital. The UK government has been supporting Ukraine throughout, sending military equipment including anti-tank weapons and armoured vehicles, as well as promising to deploy British forces if Russian troops cross Ukraine’s borders.
In a divergent move to much of the rest of the world, the Chinese central bank cut headline interest rates in January as the economy faces slowing growth and continued troubles in the domestic property market. The PBOC is doing whatever it takes to support the economy, and the prospects of higher fiscal spending from the Chinese government is enticing, though we will have to await any decision for another few months.
The macro backdrop remains supportive for risk assets, such as equities, which will benefit from further expanding global economic growth. 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 given the recent pick-up in the EU’s vaccine programme. Earnings growth has been strong during this period, as has stock market performance, however we see little catalysts for further growth and as such have moved to an underweight in European equities.
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. 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 opinions expressed in this update are those of A&J Wealth Management Limited only, as at 3rd February 2022, and are subject to change.
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