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2022 began with further concerns around rising inflation and nervousness around a build-up of Russian forces at the border of Ukraine which drove oil prices higher. Inflation continued to rise almost worldwide, and to levels not seen for 30 years in developed markets. To combat this, central banks began guiding towards much faster rate rises than markets had previously expected, which led to rising bond yields and falling bond prices as well as a sell-off in more highly priced equities in January.
February 2022 will sadly be remembered as the month that Russia invaded Ukraine. As well as the deeply troubling impact on human lives, markets also took fright leading to a sell-off in equities. Gas and oil prices spiked towards the end of the month given how big an energy exporter Russia is, after already having risen in response to rising tensions and low gas inventories. This has served to push global inflation expectations up and global growth expectations down.
March saw the world coming to terms with the atrocity of war in Ukraine, albeit heartened by the resilience of the people of Ukraine. There was a glimmer of optimism towards the end of the month as Russia seemed to signal that their ‘military operation’ was nearing an end. Markets rightly treated this with scepticism, but the month also saw investors begin to refocus on inflation and central bank tightening as the key risk to investments.
Overall, the first quarter saw generally poor market performance across most asset classes with the main exception of commodities and commodity exposed equities and regions. Commodities tend to benefit from higher inflation, but prices rose further because of shortages resulting from sanctions on commodity exporting Russia after their invasion of Ukraine. Emerging market bonds were the worst performing asset class, suffering both from rising yields and from the bonds of major constituent Russia falling due to sanctions. Continental European equities also fell heavily in the aftermath of the invasion given Europe’s dependence on Russian gas for its energy needs. Market volatility, as measured by the VIX index, rose almost 20% over the quarter. Developed market equities (as measured by the MSCI World Index including dividends) fell 2.4% in sterling terms over the quarter. The commodity heavy FTSE 100 returned 3% over the quarter including dividends. Emerging market equities (MSCI EM Index) fell just over 4% over Q1. Global bond yields rose steadily over the quarter leading to higher quality bonds (as measured by the Bloomberg Global Aggregate Index) falling 5%. Lower quality ‘high yield’ bonds also fell just over 5%. Oil was up 39% over Q1 whilst gold rose 5.9%.
Data source: Financial Express
Indices used (including interest & dividends): Defensive Investment Grade Bonds – GBP hedged Bloomberg Global Aggregate Index; Riskier Bonds (High Yield) – GBP hedged Bloomberg Global High Yield Index, Developed World Equities – MSCI World Index in GBP; Emerging Market Equities – MSCI Emerging Markets Index in GBP; FTSE 100 (UK Large Capitalisation Equities)
Diving into stylistic performance within indices, cheaper ‘value’ companies (which generally includes oil & gas companies) outperformed over the quarter, up just over 2%. Smaller companies fell slightly more than world equities, down almost 4% whilst ‘high price’ securities (often described as ‘growth’/’momentum’/’quality’ companies) underperformed over the quarter, down just over 7%.
Data source: Financial Express
Indices used (including interest & dividends): Developed World Equities – MSCI World Index in GBP; Growth Equities – MSCI The World Growth Index; Value Equities – MSCI World Value Index; Small Company Equities – MSCI World Small Cap Index
The pound had a weaker quarter overall. It fell 2.8% against the US dollar and 0.6% against the euro but was up 2.5% against the yen which itself weakened dramatically.
The PortfolioMetrix Core portfolios had a subdued quarter. Asset allocation was a slight headwind, due to a small overweight to emerging markets and Chinese domestic A Shares which performed poorly. Active fund performance also detracted over the quarter, mainly due to UK funds holding a higher weight to underperforming UK small and mid-sized companies during a period where large companies in the UK outperformed.
Sustainable World portfolios also had a weaker quarter, with their tilt towards underperforming quality/growth companies detracting over January. They had a better rest of the quarter, however, and continue to enjoy significant long-term structural drivers as the world shifts to focus more on environmental and social issues.
Moving in to the second quarter of 2022, the prevailing worry on global investor’s minds is again inflation and central bank tightening in response. The acute geopolitical risk of Russia’s invasion of Ukraine, and in particular worries over NATO being sucked into the conflict and dark threats from Russia over the use of nuclear weapons, has faded somewhat. However, sanctions on commodity exporter Russia are feeding into higher inflation and this is very much still having a big effect on economies and markets.
Source: Deloitte COVID-19 Economics Monitor, 22 March 2022
Western economies haven’t had to deal with serious inflation for decades, but its corrosive effects for everyone are starting to become all too apparent. As just one example, energy costs for consumers are increasing quite dramatically. Energy markets (in the form of the oil and natural gas that fuel power stations and cars, and heats homes) are global – so a disruption in Russian gas exports affects all countries, even those that don’t themselves import much Russian gas such as the UK.
Source: J.P. Morgan Asset Management Guide to the Markets Q2 2022
And not only is inflation serious for individuals, but it can also hinder economic growth. Firstly, consumers that have to spend more on electricity, heating their homes and transport have less money left over to spend on the other goods and services that make up the economy. Secondly, to tame inflation, central banks need to tighten monetary policy by raising interest rates and stopping or reversing quantitative easing. Tightening directly slows economic growth by raising interest rates which makes borrowing more expensive for companies and individuals. Central banks are already tightening, with much more expected from here.
Source: J.P. Morgan Asset Management Guide to the Markets Q2 2022
Perhaps the biggest market worry at present is that central banks will be forced, by inflation, to raise rates so high (or simply raise too much by mistake) that this will choke-off growth completely in future causing a recession. This is indeed a risk, and growth expectations are coming down, but is by no means inevitable given economies are still projected to grow faster than they have historically as they recover from COVID lockdowns.
Source: J.P. Morgan Asset Management Guide to the Markets Q2 2022
Nevertheless, there are other risks out there that could precipitate market falls and possibly recessions.
The war in Ukraine continues, so the risk of an escalation remains – everything from Russia using chemical or tactical nuclear weapons within Ukraine to NATO somehow being dragged into the conflict. A key wildcard at present is whether China steps in to assist Russia more directly given their historically friendly ties. This would risk western sanctions on China which would likely be far more disruptive than those on Russia given China’s global heft. Russia was only about 1.7% of world GDP in 2020 according to the World Bank, whereas China was 17%.
COVID also isn’t quite done with us. Of course, a new variant is a risk to all, but whilst the effects of Omicron have been relatively benign for countries that struggled through previous variants, it is currently wreaking havoc in China. China has, up to now, successfully maintained a zero COVID policy but is struggling to do so with many more Omicron infections. Abandoning the policy would be difficult given China’s population hasn’t built up immunity from prior infections and their home-grown vaccines appear to be less protective, but at the same time the lockdowns it is imposing are negatively impacting growth and aren’t quite stamping out the virus.
Then there remain the usual political risks, the biggest of which is that Eurosceptic and NATO-sceptic Marine Le Pen beats favourite Emmanuel Macron in the second round of the French elections on 24 April. Such a victory would immensely damage the unity that Europe has shown in the face of Russian aggression, as well as complicate EU decision-making more widely.
Despite these risks we remain cautiously optimistic around our portfolios. Equities as a whole still have some upside given strong earnings expectations and do have the potential to outperform even current high levels of inflation.
Source: J.P. Morgan Asset Management Guide to the Markets Q2 2022
Valuations also look reasonable for equities in most regions, with the possible exception of the US.
Source: J.P. Morgan Asset Management Guide to the Markets Q2 2022
Cash and bonds are, however, much more problematic from an after-inflation returns perspective. They remain crucial for diversification and for controlling risk in portfolios, but we have been actively seeking out alternative asset classes that should be able to provide further diversification and withstand inflation better. At present we use high yield bonds, emerging market bonds, listed infrastructure and real estate for this, but we have some active research projects looking at other possibilities. Overall though we continue to favour diversification as a means to building portfolios that should flourish over the long-term but are robust to the uncertainties we face over the near-term.
The first quarter of 2022 saw dramatic tightening by a number of developed and emerging market central banks. The US Federal Reserve raised rates by 0.25%, stopped quantitative easing (stopped buying US bonds) and dramatically increased their guidance around future rate rises whilst the Bank of England tightened rates by 0.5% and began to reverse its quantitative easing. Almost the sole exception was the Chinese central bank, which loosened its policy slightly to mitigate the isolated lockdowns the country is still using to control COVID.
GDP figures released in the first quarter were for Q4 2021 and were generally positive as economies continued to recover from COVID disruption. Inflation generally increased during the first quarter, in many cases to levels not seen for decades. Unemployment generally fell as economies continued their recovery from COVID.
Note: The above returns are total returns, including dividends and interest payments. Asset classes with the “HDG” label are currency hedged to pounds sterling, which means that foreign currency movements are removed whilst those with the “£” label indicate that we are reporting returns to British holders which includes the effects of the foreign currency moves non-UK listed securities are exposed to.
Data source: Financial Express
Indices used: Bank of England SONIA, GBP hedged version of FTSE World Government Bond Index, GBP hedged version of FTSE WorldBIG Corporate Index, GBP hedged Bloomberg Global High Yield Index, GBP hedged version of FTSE Global Emerging Markets US Dollar Government Bond Index, MSCI North American Index, MSCI Europe ex-UK Index, FTSE All Share Index, MSCI Japan Index, MSCI Pacific ex-Japan Index, MSCI EM Index, FTSE Global Core Infrastructure 50/50 Index, FTSE EPRA NAREIT Global Index and S&P Goldman Sachs Commodity Index
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Data Source: PortfolioMetrix, Bloomberg
*Glossary of Financial Terms
This document is only for professional financial advisers, their clients, and their prospective clients. The information given here is for information purposes only and is not intended to constitute financial, legal, tax, investment, or other professional advice. It should not be relied upon as such and PortfolioMetrix cannot accept any liability for loss for doing so. Any forecasts, expected future returns or expected future volatilities are not guaranteed and should not be relied upon. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment. Past performance is not a reliable indicator of future performance. Portfolio holdings and asset allocation can change at any time without notice. PortfolioMetrix Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. Full calculation methodology available on request.
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Consilium Asset Management are Independent Financial Advisors (IFA) based in Bristol and are authorised and regulated by the Financial Conduct Authority. More information can be found on the Financial Services Register under Number 469507. Registered Office: Vayre House, Hatters Lane, Chipping Sodbury, Bristol, BS37 6AA.
