The pork pie plot

Market report

1. Capital markets remained wobbly, with real yields continuing to rise unevenly and stock markets suffering.
2. Commodity markets provided some offset amongst risky assets amidst rising tensions on Ukraine’s border with Russia
3. The UK’s political crisis appeared to gather momentum as the near-term economic outlook darkened a little.

CIO view

Another busy and disorienting week for capital markets investors. Much of the action seemed to be driven again by a bond market trying to get to grips with the year ahead. Real yields rose for the most part, as more interest rate rises were incorporated into this year’s forecasts. This, alongside incoming news on corporate earnings, continued to force a rethink within the equity market. So far, most of the violence has been more or less contained below the index level.

There is novelty here for many investors. It has been some time since we have seen the world’s major central banks actively trying to squash, rather than boost, inflation. The answers provided by superficial glances at history are much less useful than advertised. ‘This time is different’ is a phrase now inseparable from catastrophic hubris. However, it is true, it is different every time. This does not mean history is of no use (I would say that you might rightly shout!). Understanding how and why the context for each rate rising cycle of the post-war period was different is central to how you deploy the various messages from history here.

In terms of the relationship between styles and real interest rates, it does appear that the rise in real interest rates has played the pied piper for the seismic rotation under the surface of stock markets this time. There is, as we’ve pointed out before, some intuitive sense here given how higher interest rates can affect different types of corporate cash flow profile. However, we should also be aware that this has not proved a dependable relationship in the past. The popularity of various styles of investment within the stock market – value, growth, quality, and others – have waxed and waned unpredictably in the past.

For stocks in general, there is the near-term cushion of already depressed investor sentiment. As we’ve seen before, this can argue that much of what we think we can see of that complicated near-term outlook is already baked in to prices. The level of real interest rates around the world remains strongly supportive for now, however the pace of change will likely be a key determinant of the degree of stock market dyspepsia from this point (as we have seen this last few weeks).

Our warning with regards to the escalating tensions between Ukraine and Russia should be familiar to regular readers. When the main protagonists don’t know what comes next, be wary of the legion of armchair generals ready to authoritatively second guess them. There is some cushion in our multi-asset class funds and portfolios in the form of the commodity exposure we have, both direct and indirect. This could certainly develop into another debilitating humanitarian crisis in a world surely replete with tragedy and suffering. Nonetheless, for investors, the main message is to focus on diversification across geographies, asset classes, and styles.

Finally, a denouement to the UK’s political crisis approaches in the days ahead. The prime minister may have to battle an imminent vote of no confidence following another week of bruising revelations and allegations. We obviously have very recent memory of another Conservative Prime Minister surviving exactly the same process, so if it does come to that it will be worth keeping an open mind.

For investors, there is no related action. We remain a little concerned about sterling’s near-term path and have an underweight position in our multi-asset class funds and portfolios as a result. However, this has nothing to do with the action in Westminster. The near-term outlook for the UK economy is darkening a little on the evidence of incoming economic data. A more mixed employment report and still hotter than expected inflation data are part of that. The Bank of England has some more tough choices ahead...

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