Bond yields have moved higher already this year and may well push on further, yet we believe that inflation will come down from its currently extremely elevated levels which may ease pressure on the need to more aggressively raise interest rates at that point.
There has been a heightened sense of fear this year, regarding inflation and the future path of interest rates which has meant that bond yields have risen (and so bond prices fallen) and this has impacted stocks around the world. The global stock market is down nearly 7% and the US market off over 8%, in sterling terms. Furthermore, we have seen the more quality and growth-focused areas fall most, with cyclical industries, such as energy, mining and banks perform best. This is why, for example, the FTSE 100 has performed better on the global stage, due to the fact that mining, energy and banks make up a large part of the market. Furthermore, medium and smaller companies have also fallen more than their larger sized peers, for these areas are naturally more growth-focused, and can see more selling pressure in risk-off periods. Whilst the bond funds we hold have performed well, some of the equity funds have seen quite large falls, especially those with a growth and/or medium and smaller company bias. However, it is certainly worth noting that more speculative areas/assets, that were very much in vogue until recently, are down heavily. This includes Bitcoin, which has fallen c.40% from its highs, a Goldman Sachs basket of unprofitable technology stocks is down 50% since November 2021 and the ARC Innovation fund (investing in ‘disruptive innovation’) has lost around 30% of its value this year alone. We have little exposure to these sorts of investments.
Bond yields have moved higher already this year and may well push on further, yet we believe that inflation will come down from its currently extremely elevated levels which may ease pressure on the need to more aggressively raise interest rates at that point. The market has also moved very quickly and is not, in our view, focusing on fundamentals but being blinkered by macro forces (such as inflation/interest rate rises). We expect equity performance to normalise as this settles down in due course, and this earnings season will be very important; especially as some of the more optimistic views on the cyclical sectors may be challenged and good quality companies produce attractive and consistent results. However, should this change in market leadership persist for some time then this will remain a headwind for performance. Overall, however, we remain comfortable that the funds which have struggled recently remain predominantly invested in companies with leading market positions and strong balance sheets, and these should continue to prosper in a rising inflation and interest rate environment.
Andrew, Charles, Chris, Dan, Mark & Will
The Investment Management Team, Square Mile
Tuesday 1st February 2022
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