The environment has become more difficult for investors. For some months central banks have been tightening monetary policy. The war in Ukraine and other geopolitical tensions are compounding an already problematic situation. Not least, the war is having an inflationary impact, further boosting price levels that were already elevated due to the effect of the Corona pandemic on global supply chains. Governments are trying to stabilize economies with tax cuts, stimulus packages and support for, or outright purchases of, ailing companies.
Monetary headwinds
Faced with undesirably high inflation, many central banks are in a tightening mode. The aim is to raise policy interest rates until inflation falls back to the target level of 2%. Moreover, the US Fed is withdrawing liquidity by reducing the monetary base. A shortage of US dollars and the rising interest rate differential in favor of the US have caused the dollar to appreciate significantly, putting a strain on other economies, but also on America’s export industry. A recession in several countries now looks more likely. However, the resulting decline in demand for goods and services would in turn serve to reduce inflationary pressure and thus also the need for further tightening.Faced with undesirably high inflation, many central banks are in a tightening mode. The aim is to raise policy interest rates until inflation falls back to the target level of 2%. Moreover, the US Fed is withdrawing liquidity by reducing the monetary base. A shortage of US dollars and the rising interest rate differential in favor of the US have caused the dollar to appreciate significantly, putting a strain on other economies, but also on America’s export industry. A recession in several countries now looks more likely. However, the resulting decline in demand for goods and services would in turn serve to reduce inflationary pressure and thus also the need for further tightening.
Geopolitical uncertainties
The war in Ukraine and the unstable China-Taiwan conflict are weighing on markets. OPEC and allies such as Russia (one of the world’s largest oil producers) are controlling oil prices by coordinating production and supply levels. Their actions are exacerbating the world’s inflation problem while gas shortages due to Russia’s supply freeze to its European customers will only add to price pressures over the winter.
Governments respond with fiscal policy…
The loss of consumer purchasing power and market distortions (especially in Europe’s energy-intensive industries) are prompting governments to intervene. Tax cuts and higher public spending have been announced (for example, but not only, in the UK.) Public debt is rising while higher interest rates will boost debt service burdens sharply.
…. as consumers are getting hurt
Companies with pricing power are passing on their higher production costs to consumers, hitting consumer purchasing power. For consumer durables, and in areas where spending decisions are more discretionary, passing on higher prices is much more difficult. Here, margins and profits are under pressure which will impact employment levels. Weaker consumer purchasing power and a less buoyant labor market point to a broad-based slowdown.
Capitulation of the Bank of England on 28 September
Just a few days ago the Bank of England announced that over the coming 12 months it would sell around £80bn (or roughly a 1/10th) of its government bond holdings into the market. But an ill-judged budget announcement from the UK’s new government under Prime Minister, Liz Truss provoked panic in forex markets and more importantly in British bond markets.
10-year gilts that were yielding 1.75% at the beginning of August rose to over 4.5% (a 14-year high) forcing the Bank of England to undertake emergency intervention to stabilize the situation. Thus, previous plans for “quantitative tightening” have been postponed and instead the Bank will move in the opposite direction, buying up to £5bn of bonds a day up to mid-October. Although the Bank of England’s interventions have brought some immediate calm to UK markets, longer term damage has been done to the credibility of UK institutions. The UK already has a relatively severe inflation problem and now its central bank is underwriting unfinanced plans for increased government spending and tax cuts. Even should market conditions allow the Bank of England to withdraw its current emergency market support, the Truss Administration’s expansionary fiscal stance implies that the UK central bank will have to raise UK interest rates even more sharply if its 2% inflation target is to be met.
Turmoil in UK capital markets developed in a few days, partly because of the general instability in global capital markets stemming from the trend to higher interest rates as well as other issues such as the war in Ukraine and the potential that this has for instability in Russia.
How should investors position themselves in such an environment?
Stick to the strategy, consider tactical adjustments
We expect volatility in the equity markets to continue. And should companies indicate a less positive view of business conditions and earnings prospects in coming quarters, a sustainable market recovery will be further delayed.
The investment strategy agreed with clients at the beginning of the mandate is considered a long-term orientation and should not be adjusted without strong reasons, even in current market conditions. But there is scope to act at the tactical level, particularly in the active management of the allocation as well as in adjustments to a portfolio’s geographical and sector orientation. In the current environment, we recommend a defensive investment orientation. We prefer large-cap, quality companies, emphasizing dividend income and “value” stocks. In fixed-income investments, we see interesting opportunities in short-dated corporate bonds (investment grade as well as high yield).
For investors whose mandate includes alternative investments, managed future or CTA strategies can be used as an additional diversification component. Thanks to the significant rise in interest rates, capital-protected structured products now have an increased attraction.
For new investors and investors with high cash quotas, the current environment offers the opportunity to build up equity positions in a staggered manner. Staggered purchasing reduces risk regarding entry prices while still enabling the investor to participate in a recovery or turnaround. However, we recommend caution given the headwinds currently posed by central bank tightening.
Contact: Christoph Sieger, Portfolio Manager
Telephone: +41 58 680 60 56
Disclaimer: Produced by Investment Center Aquila Ltd. Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no under-taking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information pro-vided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other trans action. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.
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