March Monthly Note
Most of the world is reeling from the recent Russian invasion of Ukraine, with Western countries scrambling to react. In Europe, the European Union have sought to stop the Russian central bank from transacting its reserves by banning any purchases of assets from the bank. Previously something that was suggested but largely shrugged off, the western world has also now banned the most influential Russian banks from the SWIFT messaging system (used by banks to conduct trillions of dollars in financial transactions), severely hindering liquidity in the local banking system and initially causing a run on banks. The Russian central bank responded by hiking interest rates up to 20% from under 10%.
These measures are almost unthinkable yet have all happened in the space of days. The impact on the Russian economy will be severe and immediate and will likely make it very hard for Putin to finance the war, given the central bank cannot sell most of its reserves.
More domestically, UK business activity rebounded in February after disruptions caused by the omicron variant, according to PMI data. UK output surged to an eight-month high in January, with both services and manufacturing accelerating sharply.
In the EU, Executive Vice President Valdis Dombrovskis said the European Commission would soon ask governments to start withdrawing pandemic-related fiscal stimulus in 2023 because of the strength of the economic recovery. The European Central Bank has been furthest behind the inflation curve among major economies and has repeatedly claimed that inflation in the bloc is transitory and will subside considerably as pandemic-induced supply chain constraints begin to ease.
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 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. The UK also represents outstanding value relative to other global markets.
There is good value to be found in European equities, particularly given the recent pick-up in Europe’s earnings growth, which has been strong during this period, as has stock market performance. The strong GDP growth in the region should also be supportive for equity valuations.
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 on their intention to significantly tighten monetary policy, which could present strong headwinds for some equities in the region, particularly those more growthy parts of the market.
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 1st March 2022, and are subject to change.
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