Multi-Manager People’s Perspectives
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Multi-Manager People’s Perspectives

The week has seen equities struggling with both inflation and growth concerns front and centre, with signs that with US inflation not having peaked, central banks will have to be even more aggressive in hiking rates, something that will, in time, have consequences for economic growth. After the inflation news in the US this week (more on which later) US money markets have begun to price in the potential for the Federal Reserve to hike rates by 100 basis points later this month; the same markets are pricing 3 rate cuts next year though, suggesting an expectation that economic growth will roll over significantly in the coming months.

Concerns over global growth have also been reflected in falling commodity prices, most notably crude oil, which traded below $100/barrel for the first time in several months during the week. The International Energy Agency reported that they were seeing signs that fuel costs were starting to “take their toll on demand”. The IEA warned that prices threatened stability in emerging markets and while demand may fall as growth slows, weakness will be offset by tightening supply as Russian supplies decline thanks to sanctions and OPEC having limited spare capacity. The IEA described inventories as “critically low” with the threat of further disruption in the coming months. Russian is still producing 11 million barrels of oil a day, only 300,0000 below pre-conflict levels but the IEA estimates that as sanctions impact the ability of Russia to maintain oil infrastructure, production will slump by 3 million barrels a day by the start of next year. Filling up the car doesn’t look like it will get much cheaper for a while. As we’ve commented before, $100 oil is a significant brake on the global economy and while priced have eased from their highs, oil at these levels remains a large headwind for economic growth.

One commodity price that has defied the trend this week is European natural gas prices, which have continued to rise to levels last seen in the aftermath of the Russian invasion of Ukraine. Relief at the news that Canada has given a permit to allow components to be released to allow Russia to conduct maintenance on the Nordstream pipeline has been offset by worries over how much gas Russia will allow to flow through the pipeline into western Europe once the planned maintenance shutdown ends on July 22nd. The prospect of reduced energy flows into Europe continues to weigh on sentiment – it will become more of an issue as winter approaches, but the summer months are important in building up reserves to meet winter demand. Even before the shutdown, flows through the Nordstream pipeline had dropped by 60%. The prospect of energy rationing, either through legislation or rationing by high prices looks very real in the coming months should Russia choose to play politics with energy supplies. European countries less reliant on Russian gas, such as the UK, will likely still the consequences of any curtailment in supplies given the likely impact on pricing. Higher energy prices will increase the problems for the central banks in that they drive inflation higher but equally slow economic growth. The Bank of England’s inflation forecast (implying it would peak around 10% in October) is based on natural gas prices of 242p/therm – earlier this week the price was 452p/therm. The UK regulator forecasted the energy price cap would climb by £800 to £2800 in October, but analysts are predicting this may well be more like £3245 in October and £3364 in January. Enjoy this current warm weather because a cold winter appears to lie ahead.

Worries over energy supplies, the wider economic slowdown, and the growing rates disparity between the US and eurozone were all cited as reasons for the euro approaching parity with the US Dollar this week. The euro fell below parity against the Dollar, trading at $0.9998 – the lowest level since the early days of the currency back in 2002 when its status as a reserve currency was in its infancy. A year ago, the euro was 1.19 to the Dollar. The fact that the Federal Reserve has already hiked rates by 150 basis points, with at least 75bps likely towards the end of this month contrasts with the European Central Bank, which is likely to begin hiking rates next week, but only by 25bps, a level which still leaves rates in negative territory despite inflation above 8%. This is not just about the euro though, we should also remember that despite the Bank of England hiking rates, Sterling is down a similar amount against the Dollar, falling 11% this year. With the Fed so aggressive in terms of hiking rates, with the BoE and ECB more concerned about growth, from a rates perspective it would appear the strong Dollar may persist for some time, something history shows normally causes trouble somewhere.

The political news has been dominated at home by the Conservative party leadership contest which is well underway. MPs will hold a series of votes to bring down the number of candidates from an initial 11 to 2, from which a new leader, and Prime Minister, will be decided upon via a postal vote of around 160,000 Conservative Party members. With 5 candidates remaining, this weekend will see several TV debates followed by the next round of voting on Monday. The result will be announced on September 5th. Italian politics saw an attempt to re-take the title of most shambolic politics back from the UK with the resignation yesterday of Prime Minister Mario Draghi after the Five Star Movement, part of his governing coalition, refused to support a €20bn relief package aimed at softening the impact of energy price hikes (their argument being the package does not go far enough). Draghi’s resignation was rejected by President Sergio Mattarella who asked him to seek re-approval as Prime Minister next week. Should this fail, elections in late September may well be on the agenda. Further afield, last Friday saw the shocking news of the assassination of Japan’s longest serving Prime Minister, Shinzo Abe, while he was campaigning for his party ahead of elections that took place last weekend. Abe stepped down due to health issues back in 2020 but remained a huge influence on Japanese politics and his Liberal Democratic Party. The LDP secured an increased majority in the elections which gives them enough seats to attempt to amend the constitution to allow the country to maintain an army – this was one of Abe’s policy goals, along with the domestic reforms to the economy that have taken place under the banner of ‘Abenomics’. There is also now a large time gap until the next elections in 2025 giving current Prime Minister Fumio Kishida time to implement his own policy agenda, which so far has amounted to very little.

In the economic data, the US saw another strong month of jobs in June with a far better non-farm payrolls report than expected. The US created 372,000 jobs in June, versus 265,000 expected. Such levels of job creation are not consistent with a recession though employment is a lagging indicator – plenty of leading indicators are painting a bleaker picture. US inflation surprised to the upside once again, with CPI up 1.3% month on month and up 9.1% versus June 2021; this is the highest pace of inflation since 1981. Core CPI (which excludes food and energy) was up 0.7% month on month, highlighting again that inflation continues to broaden across the economy. The data left financial markets with little doubt that the Federal Reserve will raise raises by at least 75 basis points again at the end of the month. Overnight we have seen China report second quarter economic growth data, with the economy contracting 2.6% versus the first quarter. This is the first contraction since Q1 2020, which was also impacted by Covid restrictions. Year on year growth was just 0.4%. The Chinese authorities remain determined to reach their 5.5% growth target so a strong rebound – likely helped by stimulus – is needed in the second half of the year, but of course that assumes China can balance ‘zero-Covid’ restrictions with boosting economic growth. China reported 432 Covid infections yesterday, a 7-week high.

Our monthly asset allocation meeting took place this week and we maintained our cautious positioning, remaining underweight in equities but we have taken a slightly more positive view on bonds as the market narrative shifts away from inflation (even though it may well not yet have peaked) and towards slower economic growth. Given the yields now on offer, we think selectively adding to some bond funds now looks attractive with the risk/reward more favourable than we have seen for a considerable time. Our regional views remain unchanged, so we continue to favour Asia over other parts of the world, and we are considering paring back our UK exposure – a market that has held up well thanks to high commodity prices but now appears to be rolling over. The UK also faces considerable political and economic uncertainty in the coming months, so while we do still see positive stories and themes from the bottom up, our concerns over the top down are mounting. Overall, we continue to see significant risks to the global economy and while we do see a lot of bad news already priced in, we believe that this is not yet reflected in corporate earnings expectations, which will need to be revised lower if we are indeed heading for a weaker economic backdrop.

We will reflect more on the current economic situation and the outlook in our webinar next Thursday, for which you can register here.

15 July 2022
Anthony Willis
Anthony Willis
Investment Manager
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Risk disclaimer

Please note that this is a marketing communication and does not constitute investment advice or a recommendation to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. Views are held at the time of preparation.

 

Past performance is not a guide to future performance. Stock market and currency movements mean the value of investments and the income from them can go down as well as up and you may not get back the original amount invested.

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