Investment Update – Spring 2022
In the year to date, the most significant reference point for financial markets has been the Russian invasion of Ukraine.
Russia has a strategically important role as a leading global commodity supplier. In 2021, it was the world’s third largest supplier of oil and also produced 40% of the natural gas consumed by the EU. This reliance poses a significant problem, particularly for Europe. In the short-term, the choice appears to be between a country continuing to buy Russian products (where this is still legally permissible) and therefore helping to fund Putin’s war, or to potentially induce energy shortages, eyewatering price increases and ultimately recession for its own people and economy where it is not.
Going forward, countries are likely to think far more clearly about the wisdom of placing control of a wide range of matters in the hands of neighbours, thereby further enhancing the deglobalisation motion.
Russia and Ukraine also collectively export a quarter of the world’s wheat and a sizeable proportion of other grains. Both nations will likely face a reduced willingness, or ability, to supply food products to the rest of the world over the next year and beyond, thereby threatening global food supply chains. In the event that richer nations might hoard limited supplies for their own consumption in a temporarily shrinking market, poorer countries without sufficient domestic production may run the risk of facing food shortages, with likely devastating human consequences.
As events unfolded, this inevitably brought sudden shock to commodity supply chains, resulting in soaring commodity prices across the board in a short space of time. The diversified Bloomberg Commodity Index is up 32% YTD in USD terms. Although this can be a boon to those selling, it can represent financial hardship to those buying. Such changes have been sudden, thus explaining the violent reaction of financial markets.
Naturally, spiking prices in all directions inevitably leads to an inflationary destination. Prior to the invasion, financial markets were debating whether the inflationary pick-up during 2021 was ‘transitory’ and about to fizzle out (with 2021 inflation largely the story of Covid supply shocks in 2020 – in many respects, a similar parallel). Suddenly, elevated inflation is now likely to be with us for at least another year. The jury is out on whether higher levels of inflation than seen in recent years might be here to stay more permanently.
Bond markets were especially hard hit by this possible reality, on some counts registering their worst quarter for several decades. The FTSE All Gilts index (representing UK Government Bonds) is down just under 10% YTD at the time of writing – hardly a safe haven, losing more than almost all major stock indices. Longer-dated issues are down further still as market interest rates surged in anticipation of central banks needing to hike rates in order to get inflation back under control.
This comes at a time when global stocks have also lost money in the calendar year (with MSCI World down 3% in GBP terms, Emerging, European and Japanese markets falling between 6% and 9% and the higher beta US Tech-heavy Nasdaq index down 10%, all in GBP terms, at the time of writing). Russian equities lost almost all their value, as markets priced in a possibility of total loss.
Seeing both Bonds and Equities falling together is a big wake up call for the traditional 60 (Stocks)/40 (Bonds) portfolio. This has worked well over the past few decades (with past winners, such as Tech and other extreme Growth vehicles trading at lofty valuations, also falling the hardest in the stock market) but now appears to be changing. This is explained for the most part by the poor value on offer for both asset classes at headline level (not least as rising interest rates are mathematically able to threaten both sides of the ledger – something we have been warning about for some time).
This dynamic has been less of a threat for most KMD strategies, with consistently lower sensitivity to interest rate rises through holding lower duration Bonds or All Weather funds as an alternative (which to generalise have held up better than most Bond types).
Amongst equity markets, the FTSE 100 index (with its large Energy and Commodity exposure) and MSCI World Value indices have bucked the trend, registering light gains so far of 3% and 5% respectively YTD in GBP terms.
Furthermore, exposure to Real Assets (Commodities including Gold, Infrastructure, Real Estate) have been inflation beneficiaries and could continue to be so from here. This performance grouping illustrates in no uncertain terms why the principle of diversification matters.
A further economic consequence of inflation is that higher prices hurt the consumer or the firm, acting as a brake on economic growth, thereby raising the risks of global or regional economic slowdowns or even recession. Some regions, such as Europe, could be especially squeezed, far more than say the USA. For this reason, some sharp divergences have been observed between various regions and asset types.
It may well be that the trends so far seen in 2022 will serve as something of a dress rehearsal for what might be expected over the next decade, albeit likely with several twists and turns along the way. The KMD strategies have generally been well positioned for this set-up with some portfolios holding up far better than peers who were more aggressive in their focus on short-term rewards (and past big winners). Therefore, although the tone may sound negative, we remain confident in our ability to deliver diverse strategies for a range of market conditions, but particularly a continuation of the present trend which does not appear to be over.
The details, views and opinions expressed above are KMD’s, can change at any time and are not intended to be advice or a solicitation to make an investment. Professional advice should be sought before acting on any information contained in this document. The value of investments can fall as well as rise and your capital is not guaranteed. Past performance is not a reliable indicator of future performance.