Top investor concerns

This week we again look at some of the most pressing questions facing investors in amongst a still turbulent macroeconomic backdrop. From Gold's incredible surge to the continuing sell-off in stocks and bonds amidst escalating tensions in the Middle East, we discuss the threats and opportunities at play and on the horizon.

Inflation – too soon for the all clear?

The dramatic sell-off in bonds speaks of returning fears on inflation. In the US, a succession of marginally disappointing inflation readings has jolted the doomsayers back into action after an all-too-brief slumber. Even UK related data has disappointed a little, helping to defer expectations of the first Bank of England rate cut deeper into the summer. In the US, some are even speculating that policy rates may have to rise further still.

There is a sense that these economies may still be straining at the leash a little. Incomes, and therefore demand for goods and services, are perhaps still growing a little faster than supply. Perhaps the monetary medicine intended to remedy this mismatch (and so cool prices) just needs more time.

In any case, we are thankfully a long way on from the depths of the cost-of-living crisis, even if many of the societal scars remain livid. Price pressures have moderated substantially and, allowing for measurement error, are within touching distance of central bank targets. Meanwhile, there are still plausible disinflationary forces ahead - some of the notable areas of price warmth in the statistics this last few prints could well have further to cool in the months ahead as the contortions of the pandemic continue to relax their grip.

…but what about soaring commodity prices?

There has been a pronounced recovery in prices across the commodity complex, from precious to industrial metals. That, and the rise in oil prices, will provide some offset to those disinflationary forces mentioned above, if they aren’t already. (Figure 1)

The reasons for these broad-based rises are many and various. Oil and parts of the industrial metals complex have both demand and supply factors at play. That the global economy is in significantly better health than forecasted is certainly part of it.? The Baltimore bridge accident and Houthi attacks in the Red Sea are also playing a (negative) role on the supply side. Aluminium is particularly affected amongst metals by the former.

Threats to the supply of oil are front and centre of course and a great deal of humility is appropriate in any forecast here. While there are clearly important actors incentivised to keep the current Middle East conflict from spilling over, there is always room for misstep. This morning's news of retaliatory strikes from Israel deep in Iranian territory ratchets the threat level higher still.

Gold is something different. The ‘barbarous relic’ seems to have disconnected from its usual (but rarely reliable) market influences, particularly real interest rates which have been rising of late. There is a strong structural demand story in the background here with several legs. Emerging market central banks have been diversifying away from the US dollar into gold, while Chinese households may have been turning away from the nosediving property and stock markets.

Layered on top of this demand, some returning worries about sticky inflation in the US and elsewhere seem to have spurred speculative demand from hedge funds and other money managers.?

The overall picture for commodities is best described as heterogenous (as usual). We hold commodities in our various funds and portfolios not because we think we can reliably call the direction of spot prices but rather as a diversifier to our other assets. Historically, the returns on offer, most plausibly linked to something called ‘storage theory’, tend to move differently to those provided by stocks, bonds, and credit. As recent moves in gold and oil suggest, there is also some geopolitical insulation seemingly on offer at times, though we wouldn’t over egg that one.

Can this corporate earnings season bail out stocks?

Equity markets’ incredible start to the year has faltered in amongst all this. Higher interest rates across maturities and geographies may be forcing investors to rethink valuations a little. Or it could just be a familiar pause for breath following the rapid ascent since the end of October last year.

Into this sensitive moment arrives another corporate earnings deluge. We would repeat our usual disclaimer here – most earnings seasons offer a lot more noise than signal. They are better characterised as a game of cat and mouse between equity analysts and CEOs, as the shape of earning estimate revisions year after year suggests. (Figure 2)

We will be keeping an eye out for signs of fundamental support to the recent broadening in stock markets (before the pull back).

Investment conclusion

There remains a lot of noise out there in markets. Much can be ignored (as usual). The daily hurly burly of price moves and reactive commentary mostly contain very little signal for the medium to long-term investor. There are hints of a regime shift. The world economy and capital markets increasingly bear very little resemblance to the norms of the last economic cycle. That may be illusory, but the wise investors will prepare for both (and many other) worlds.

And don’t forget, we cover these themes and more in our weekly ‘Word on the Street’ podcast. Find out more, here.

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