Written By Marcus Rayer
This monthly update shall be one that provides an element of realism whilst also retaining some cautious optimism. Investors’ short-term return expectations need continued management given the current economic backdrop, with more emphasis to be placed on longer-term returns.
Over time, it is in a market’s nature to endure difficult periods and they have done so regularly in the past. Therefore, it could be seen as wise to take lessons from the past and ‘batten down the hatches’ remaining invested for the longer-term. With future returns now looking more attractive than they were at the start of the year, diversity across a range of investment assets remains a prudent investment strategy.
The first half of May showed continued signs of “stagflation”, also known as a time of stagnant economic activity. This is a negative economic background for being invested in traditional portfolios that are largely made up of bond and equity investments. Inflation fears tend to send bond yields higher (and capital values lower) and higher bond yields then weigh on the valuations of risk assets like equities.
Such economic periods reduce company earning potential, meaning that both elements of the Price/Earnings ratio (the traditional valuation yardstick for equities) are under simultaneous pressure. Adopting a defensive strategy in such circumstances can therefore be largely achieved by trying to limit losses and maintaining a longer-term view on investment strategy.
The latter part of May did bring some hope, although it might be more accurately described as a ‘peaking of the economic pessimism’ rather than a transition into newfound optimism. It may be perceived that central banks are not able to raise interest rates as far as anticipated due to the negative effect it would have on the economy. This has meant that rate expectations and bond yields have reversed, thus helping to alleviate some of the pressure on equities. However, we cannot say we are now in the clear at this time.
Eyes have, as such, reverted their focus on the US Fed, who are currently engaged in trying to slow the pace at which prices are rising in the world’s largest economy. This is being attempted by trying to dampen demand through raising short-term interest rates, but they are also attempting to tighten financial conditions by taking some of the air out of financial assets.
The Fed has been deliberately trying to send stock markets lower as part of its strategy to keep inflation under control. The effect of this will be that unless inflation begins to subside quickly, any meaningful rally in equity markets will be met with tighter policy. The results of the Fed’s approach will undoubtedly have a knock-on effect around the globe with many countries also trying to keep longer-term inflation expectations under control.
Another policy technique is that of balance sheet management. Central banks around the world flooded markets with liquidity in response to the Covid crisis, one of the factors that helped to buoy more speculative assets once the recovery got underway. One by one, they are turning off the liquidity taps and now even removing the plug.
It is therefore a time to hold our resolve and not chase short-term gains, but instead take a longer-term view on investments within a diversified portfolio to realise your financial planning goals. It could therefore be seen as a good time to consider running towards markets, not away from them.
If you have any questions arising from the above, please do not hesitate to get in touch with an Integrity365 Independent Financial Adviser today on 0117 450 1300.
Written By Marcus Rayer
