I hope this bulletin finds you well and having enjoyed the warmer weather over the weekend. After some heavy BBQ grazing on Saturday the diet definitely starts today…
I wrote a blog earlier this year recommending that we fasten our seatbelts and prepare for a bumpy ride during the months ahead in 2022. Well, investment markets and the economy certainly haven’t disappointed in that regard. After near straight-line performance in 2021 provided a largely stress free journey to stellar returns, volatility has returned in earnest, resulting in investors begrudgingly giving back much of those gains.
The global economy currently stands at a crossroads, with two diverging paths before us. So what are the causes for this and how might the direction of travel over the coming months affect us? Read on and I shall elaborate. With so much happening in the world this piece is a longer read than usual, so probably worth making that cup of tea or coffee before jumping in.
The Spanish playwright and poet Federico García Lorca once wrote:
“I know there is no straight road
No straight road in this world
Only a giant labyrinth
Of intersecting crossroads”
Whilst a metaphor for the many diverging pathways of life, his insightful comments could just as easily be applied to financial planning, investment management and economics.
After a straight and clear route to exceptional returns in 2021, we now find ourselves travelling a maze of winding pathways, with the future unclear and the global economy poised at a particularly significant branch in the road. Inflation, interest rate hikes, war in Ukraine and China’s belated Covid lockdown, have all made their presence felt this year, weighing on markets and denting investor sentiment. The key debate now, is whether global economies are strong enough to shake off current challenges and continue on the sunny road to further growth, or whether we should be reaching for our raincoats and umbrellas for the next leg of the journey.
US markets – the biggest component of nearly all managed portfolios - have already suffered in 2022. Part of this is due to a sharp tech sell-off, which began at the start of the year and developed in recent weeks. Big tech stocks like Microsoft, Amazon, Netflix, Alphabet (Google), Apple, Samsung and Meta (Facebook) have all been darlings of the stock market in recent years. Covid-19 lockdowns were as much an opportunity as a threat to businesses like these. Many were either well-placed at outset – or able to pivot quickly despite their size - to take advantage of the working from home revolution, delivering bumper returns and continuing their march to ever greater scale.
The valuations of these types of companies are, however, heavily driven by expected future earnings. As a result, the Fed raising interest rates coupled with a more cloudy outlook for the global economy, has knocked their values substantially. Many of the holders of these stocks are small private investors, whose inexperience often shows itself when conditions tighten, running for the door at signs of trouble, rather than taking a long term view. Those of us that have been around long enough will no doubt remember the Dot Com crash at the turn of the 21st century and some commentators have drawn parallels between that tumultuous event and the clouds currently forming above today’s tech-giants. However, this does not seem a relevant comparison. Unlike many of the stocks of the early days of the internet boom, today’s technology leaders have clear track records of success, proven business models and substantial reserves. This gives them much stronger foundations upon which to weather a storm than many of the flimsy, early-stage companies that came in and out of vogue during the arrival of the new millennium.
An asset class without such strong foundations is crypto currency. The Crypto-10 index is a composite of the biggest crypto-currencies, such as the seminal Bitcoin, Etherium and Ripple. It is currently seeing a sell-off of epic proportions, having shed 68% over the past twelve months. Warren Buffet once spoke of investment markets being driven by fear and greed, and currently the crypto market is gripped by the former as investors dump their holdings in a panic. Sadly, those most likely to be getting their fingers burnt are the younger generation, drawn to the anti-establishment cool and pioneering spirit of Bitcoin and its crypto cousins. Over the past twelve months, social media platforms like Instragram and Facebook have been awash with twenty-somethings proclaiming themselves as crypto traders and entrepreneurs. Overconfidence bias is an ever present danger to inexperienced investors and when the going gets rough they are the most likely to lose their resolve and flee for the door. Instability and opacity are prime reasons why our portfolios do not hold Crypto assets. In a year like 2021, it would have been easy to view their meteoric rise and wonder why we weren’t participating. However, this year is a stark reminder of why most investment managers do not expose their clients to the vagaries of an asset class so prone to extreme movements in price.
The flood of private investors and speculators selling out of their investments – many no doubt at heavy losses – is then, a major contributing factor to short term movements in markets. However, whilst it may have driven markets lower for now, it may also have a positive impact on the economy and the labour market overall. In the period following lockdown, as many businesses have boomed, there has been a terminal shortage of skilled labour available in the market place. This has pushed up wages and is currently causing headaches for many companies, with a spate of resignations as staff are picked off by well-heeled competitors. This shortage of good people may have been driven in part, by the pent-up savings amassed by fledgling investors, who staked their lockdown-savings on tech stocks or crypto and saw significant short-term gains. For some it may have seemed that investment and crypto trading from home, was a viable and preferable alternative to returning to conventional employment. Recent falls in crypto currencies and tech stocks will likely have changed the minds of many, who may now be compelled to return to the jobs market, easing pressure on employers currently struggling to fill roles and meet demand.
Central banks raising interest rates in recent weeks has also been seen as a potential indicator of a recession looming and certainly a key factor in the temporary decline in investment markets. However, there are already signs that they may have achieved their goal of cooling inflation, with indications that we may have reached the peak. If this is the case, this will take the pressure off central banks to make further rate rises, which in turn will provide relief to businesses. However, as one of the Tatton team opined – ‘you can’t tune a violin with a hammer’. Interest policy is a blunt instrument and it takes time for the full impact of rate rises to be felt, so we’ll have to wait and see how both these latest rate-changes and inflation pan out.
Clearly, the jury is still out over whether we’re heading for a recession or not, with many factors influencing the direction of travel. The war in Ukraine and China’s current Covid woes are additional pressures, one of which has been covered in previous blogs, with the other potentially a topic for another day.
Even if we do find ourselves on the gloomier path and global economies do contract for a period, it is worth remembering that recessions are a normal part of the economic cycle. Economies cannot perpetually expand without pausing for breath from time-to-time. In this situation we will likely see investment markets move lower in the short-term. However, as long term investors we measure our returns in years, not days and weeks. Our investment portfolios are well-diversified, investing in leading companies all around the world. This makes them elastic, meaning they flex – not break – during times of market stress. This also gives them the potential to spring back to value quickly when conditions improve. Whilst the past performance portfolios is not a guide to the future, history repeatedly shows that investment markets have an uncanny habit of delivering some of their best returns in the years that follow some of the most challenging.
Kind Regards
James Wetherall
Managing Director
