June Monthly Note
The government have recently announced a 25% so-called windfall tax on the profits of large energy companies to help with the cost-of-living crisis. It is expected that this levy will raise roughly £5 billion to finance one-off grants of £650 to over 8 million of the poorest households in the country. The announcement was not positively received by big business or Conservative party politicians, who fear such taxes will do little to aid the cost of living but will discourage investment at a time when it is most needed.
The UK has signed its first trade agreement with an American state, with government sources saying the deal with Indiana will help remove barriers to trade and investment, improve procurement processes and move towards professional qualifications being recognised in both countries. Whilst positive indeed, a broader deal on a national level looks to be far away as Boris Johnson’s Brexit stance is hindering progress, with President Joe Biden’s administration taking a firm line on the UK government over Northern Ireland. State-by-state trade agreements seem more likely moving forward as the government expects to secure a further six deals with other US states by the end of the year.
As global food prices soar, Russian President Vladimir Putin has offered to facilitate grain and fertiliser exports, on the condition that sanctions against Russia are lifted, something Western allies are highly unlikely to agree to as they look for ways to move grain out of Ukraine and past Russia’s blockades. Ukraine is one of the world’s largest grain exporters and has been unable to move much of its produce due to the ongoing war with Russia, stoking inflationary pressures further.
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.