Thus when inflation is rising, the price of a bond will usually fall and its yield, therefore rise in order to compensate.
What were the main macro themes and drivers for the quarter?
Inflation has certainly been the main thing on investors’ minds over the last three months, as it continued to take hold in a broadening range of goods and services. Although certain to rise even more in the months ahead, we are confident that inflation will ease in 2023. The key questions are what level inflation will fall to, especially if a wage-price spiral has become established and what the cost of controlling it will be in economic terms. The tight rope on which central banks are treading as they navigate a path between the pearls of inflation and recession grows ever narrower.
It was only last summer that central banks were dismissing the first stirrings of inflation after years of dormancy as transitory. At first confined, largely to oil and gas markets inflation now seems to be evident in almost all goods and services. And although exacerbated by these events, it can no longer be blamed solely on the conflicts in Ukraine and COVID lockdowns in China.
How did bond markets perform in light of these conditions?
Against a backdrop of raging inflation and rising interest rates, investors in bond markets enjoyed another wretched quarter. As a reminder, inflation is the nemesis of most bond markets because it erodes the value in real terms of interest payments and the final repayment of capital when a bond matures and is repaid, both of which are fixed.
Thus when inflation is rising, the price of a bond will usually fall and its yield, therefore rise in order to compensate. Indices recording the returns of the conventional UK government guilt market were down another 7% in the second quarter of the year, taking the loss since the beginning of the year to 14%. So much for the safety of government bonds. Rising yields and tumbling prices though are not just a UK phenomenon investors in the broad US treasury market lost 3% in the last quarter, as yields continue to rise and have now lost just under 9% since the beginning of the year. Turning to bonds issued by companies as opposed to governments. Growing fears of an economic downturn and the impact this would have on companies cause prices of corporate bonds to fall by even more than the equivalent government bonds. Looking forward, the extent to which bond yields have risen since their lows in August 2020 means there is now at least some scope for them to fall and therefore bond prices to rise if economies do fall into recession. Government bonds are clearly not though primed to provide as much protection as they did at the start of the .com bust in 2000 or the beginning of the financial crisis in 2007 when 10-year guilts yielded more than 5%.
How about equities? It seems there was really no place to hide for investors.
The correction in stock markets deepened in the second quarter of 2022, having lost just over 4% in the first three months of the year global stock market indices slumped by 14% in the second quarter, taking the year-to-date decline to almost 18% in local currency terms. Although this provided a very rude and unwelcome awakening for many investors it is important to put the recent performance of stock markets into perspective.
Despite their falls. This year, global equity industries are still up by more than 11% PA, including dividends in local currency terms over the last 10 years. Returns of such magnitude were never going to be sustainable and a large part of them can probably be attributed to more than a decade of artificially low-interest rates and bond yields engineered by central banks.
Given that the key elements of the macro backdrop were broadly the same as in the first three months of the year. It is not surprising that regional variations in stock market performance were similar in the second quarter of the year to the first. Amongst developed markets, the UK and Japan were the most resilient in local currency terms and the US and European markets, were the weakest. Down by just 5% in the second quarter of the year, and also year to date. The UK stock market as a whole continues to benefit from its heavy weightings in multinational companies, which generate a high proportion of the revenues outside of the UK. Old economy stocks, such as mining and oil stocks and its dearth of technology firms.
Once again, though, there was a substantial divergence between indices representing the performance of the UK’s largest companies and the much weaker performance of medium size and smaller UK companies whose fortunes tend to be more aligned to the domestic economy. It was therefore another tough quarter for active managers who understandably tend to be drawn to the more exciting growth prospects, the medium size and smaller companies in the UK.
We cannot promise that share prices will not fall further in the months ahead. However, equity markets will recover as they always do. And recent weakness is enabling many of the active managers we use in the portfolios to buy into great companies at very attractive prices. Anyone who invests in shares should be doing so for the long term. And although the recent past has been painful, we’re confident that equities will continue to provide returns, which are better than inflation and other mainstream asset classes over any extended timeframe.
Park Hall Financial Services Limited is authorised and regulated by the Financial Conduct Authority.
The information within this article is for information purposes only and does not constitute investment advice. They represent the opinions of the fund manager and those of Square Mile. It does not contain all of the information which as an investor may require in order to make an investment decision. Any reference to shares/investments is not a recommendation to buy or sell. If you are unsure, you should seek professional independent financial advice.
Past performance is not a guide to future performance. The value of any investment and any income from it is not guaranteed and can fluctuate depending on investment performance and other factors. you could get back less than you invested.
Some investments, e.g. property, may be difficult to sell and will be subject to market conditions at that time. Their value is the opinion of an independent valuer.
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