Q2 Market Update & Market Insights Webinar

Welcome to our latest investment commentary covering the second quarter of 2022.

This update provides some more in-depth commentary on the markets and our views moving forward.

Q2 REFLECTIONS

The difficult start to the year for markets has unfortunately continued, with most global markets seeing large falls. Our portfolios have fallen, with the higher risk options falling the most as expected. The importance of focussing on the long term is paramount during these times because at some stage, the backdrop will improve and the markets will recover; we should not get drawn into making short-term decisions.

Whilst equities have had a tough time, the bond markets have also seen heavy falls with US Treasuries seeing their worst start to a year since 1788! We have seen the bond markets as a source of unnecessary risk for a few years now and thankfully have had very little exposure where possible; our higher risk core active portfolios had no exposure to bonds at all.

It is also important to note that we are not alone with the falls seen this year. We do track our peer group, especially the larger players in the market, and are pleased to say we are performing relatively well. Below is a year-to-date chart of our Growth portfolio gross of Carrington fees against some of our larger peers; Brooks Macdonald, Brown Shipley, Close Brothers and Vestra. They manage approximately £60bn across them and as is evident, we are holding up well.

A key reason for the improving relative performance is because we have been very active in making adjustments to the portfolios throughout the year. Since we operate a number of portfolios across different risk levels, not all of the changes will be applicable to every portfolio however here are some examples:

• Reduced exposure to our higher growth areas during the first week of January in favour of lower risk investments.
• Increased our exposure to the US Dollar in mid January because we felt it could appreciate against the Pound. This has helped as the Dollar has moved materially higher.
• We changed our healthcare exposure from mid caps to large caps in February; large caps have lowered the volatility and have outperformed since.
• Owned few if any bonds in our core active models. The exposures we kept have done relatively well as have our mix of hedge funds.

Whilst these are examples where enough time has passed to demonstrate they have worked, we have recently implemented further changes and are now waiting to see how these will pan out. The Pound/US Dollar exchange has fallen to below $1.20, which has acted as a buffer for some of our overseas holdings. We tilted the portfolios to capture this as mentioned. However, the exchange rate is now at the lower end of the long term range and so we have decided to gradually reduce our exposure, bringing currency hedges back into the portfolios.

A further development has been in the bond markets. The US 10 year Treasury bond approached a yield of 3.2% two months back. We felt this was approaching a reasonable entry point and so we decided to dip a toe in. The US 10 year Treasury then rallied but then fell again, approaching a yield of 3.5%. In keeping with our thinking, we decided to add more to bonds. This finally appears to be working, with the bond markets staging a rally over the past few weeks.

We would now like to review the previous quarter before moving on to our outlook.

Q2 2022 REVIEW

Market Performance

It has been an incredible start to the year, with the inflationary backdrop continuing to lead to a material pick up in volatility across multiple asset classes. Year on year US CPI (inflation) hit 8.6% last month and UK CPI 9%.

Following a positive end to Q1, the markets immediately got off to a tricky Q2, with most equity markets falling at least 10%. Again, the bond markets weren’t far behind, with Government and Corporate bonds falling too due to the threat of higher interest rates. The 2068 UK Index Linked Gilt was down as much as 45% on the year!

Once again, the quarter was one of two halves. The first half of the quarter was a continuation of what we saw in early Q1 and was driven by the hawkish rhetoric from the US Federal Reserve as well as other Central Banks. Given the rise in the cost of living, as well as rising interest rates, the markets began to focus on the building recession risks. This started to impact the more economically sensitive parts of the markets, that had weathered the inflationary environment so far. We also began to see the Government bond markets recovering, which is typical when recession risks are building.

As far as sectors were concerned, energy and commodity related areas initially performed well but then gave up their gains as the quarter progressed to end flat. All of the other major sectors were negative over the quarter, with the Consumer Discretionary in particular getting hit as the cost of living soared higher.

We have noticed in the recent past that Asian equity markets and in particular China have started to outperform most other markets, especially the US. We know that China has been through a period of pain for a while now, much of which was Government induced as they cracked down on excesses and social inequality. Whilst the Western world is dealing with high levels of inflation and rising interest rates, China has a relatively low level of inflation and the People’s Bank of China (PBoC) has actually been easing policy. We are monitoring this to see if a new trend emerges.

2022 OUTLOOK

Inflation & Central Banks

Energy prices remain elevated and are unlikely to fall much whilst the Ukrainian invasion continues, creating a number of energy related issues. Wage inflation is widespread and is gaining momentum as the wider public feel the pressure of the higher cost of living. Supply chains remain challenged and have been slow to normalise. As a result, we are likely to see structurally higher inflation in the years ahead.

However, there are components that could ease as consumer demand falls. We monitor inflation expectations, which act as a barometer for future inflation and they have been falling since March this year. We, therefore, believe we could see some easing in the headline inflation data over the course of the year. That is likely to be a positive for markets.

For now, the Central Banks are focused on the headline data and that has shown no signs of abating just yet. The Central Banks are therefore likely to continue on their suggested hiking paths for now. All eyes will be on the next US CPI print on 13th July.

Recession Risk

As mentioned, the markets are starting to turn their attention towards the risk of a recession. This has led to the economically sensitive sectors starting to struggle more recently and Government bonds beginning to stage a recovery.

However, a further development is that the markets may finally be looking at the fundamental merits of individual companies again. These have largely been ignored this year due to the macroeconomic factors at play. We have noticed in the past few weeks that some of those companies have started to recover as the economically sensitive sectors have been falling.

This is important because in the inflationary environment, we have favoured high quality companies, which are profitable and have pricing power such as Microsoft. These are the types of businesses that are best positioned to weather the current backdrop. However, they have instead seen their share prices fall this year and, in some cases, heavily. We are seeing signs that the markets are beginning to move in our favour and relook at these high quality companies.

We are therefore relatively happy with our equity exposures at present. However, Government bonds tend to do well when recession risks are building. As mentioned, we have already added some to the portfolios and will be actively looking at how we can build out more exposure.

Summary

Whilst markets have started the year on a weak footing, we are monitoring the fast changing developments and the prospect for some of the headline inflation data to begin easing. Volatility is likely to remain elevated, however.

We will continue to make adjustments to the portfolios over the coming months to help dampen volatility and navigate the environment ahead.

MARKET INSIGHTS WEBINAR 

If you missed our recent webinar or you would like to revisit it, please click on the recording below to watch at your convenience.

We hope you find this review informative and look forward to hearing from you if you have any questions.

 

 

 

 

 

This publication has been prepared for information purposes only by Carrington Investment Consultants Ltd t/a Carrington Wealth Management and does not constitute financial or investment advice. The value of investments, and any income generated from them, will be affected by interest rates, exchange rates, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which it invests. Investors should be aware that the value of units may well fall as well as rise, is not guaranteed and that past performance is not a guide to future performance. Different funds carry different levels of risk and investors may not get back the full amount invested.