January Monthly Note
The Bank of England raised interest rates for the first time in more than three years in December, as inflation continued to soar above target. The BoE was coming under increasing pressure from global organisations such as the IMF, which urged them not to wait and to act on inflation before it became a problem. Interest rates were increased to 0.25% from 0.1% previously. The base rate is used to charge other banks and lenders for deposits at the Bank of England.
Europe’s biggest countries are weighing the potential for more curbs to curtail the rapid spread of the omicron coronavirus variant, ranging from another lockdown in the Netherlands to stricter travel restrictions introduced over the Christmas period. This comes soon after France has introduced travel restrictions from the UK. There is much debate in the scientific and medical communities as to whether the omicron variant produces milder symptoms than previous strains and how best to combat the mutation. Germany designated the U.K. as a virus variant area from Monday, the highest risk category, requiring incoming travellers to undergo a mandatory 14-day quarantine, regardless of their vaccination status. France is considering health passes at work.
US inflation hit a 40-year high, coming in at 6.8% for 2021 and well-ahead of the Federal Reserve target of 2%. The increase was driven by energy prices initially, with gasoline rising by 58.1% in November. Following the inflation data, President Joe Biden released a statement saying that the inflation rate “does not reflect today’s reality”. The White House has maintained its stance that inflation will remain transitory (temporary), although the Fed has begun to take a different line publicly acknowledging that inflation may be stickier than first thought. The Fed have begun to taper their asset purchases faster as a result and are predicted to raise interest rates three times in 2022.
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 of 31st December 2021, and are subject to change.
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