Q3 MARKET UPDATE & MARKET INSIGHTS WEBINAR
We hope you have had a good summer and that you and your family are all well. From the looks of things,
we’ve all needed a good break in order to keep up with the ever-changing political landscape and U-turns!
So, before anything else changes, welcome to our latest investment commentary covering the third
quarter of 2022. Before we begin, we wanted to share some broader thoughts with you.
Short-lived corrections (a significant market drop) are something that we have become accustomed to.
This current period of weakness has, however, dragged on for some time now and it not something we’ve
experienced for many years. We understand this can be unsettling and want to assure you that we are
here for you, so please feel free to get in touch for a chat if you have any concerns.
What has been unusual about this period is that most asset classes have fallen together; equities, bonds
and Gold for example. This has left very few places to hide and has meant that both low and high-risk
portfolios have come under pressure.
Whilst it is easy to get caught up in the negative news flow and market action, it is important to
remember that this period of weakness won’t last forever. Over the long term, corrections have come in
all shapes and sizes but there is one common trait with them all; they do come to an end.
Quite often, the catalyst for the end of the weakness can come as a surprise, with markets moving sharply
higher. It is therefore important to remain invested because research suggests that missing those positive
periods can have a material impact on long-term returns.
We have remained invested throughout this period. However, as you may have gathered via our
communications throughout the year, we have been working hard to reduce the volatility in portfolios.
This approach has helped but also ensures that when the recovery arrives, we will be in a position to
capture it.
We will now move on to some more in-depth commentary on the markets and our views moving forward.
Q3 REFLECTIONS
Where to begin?
The quarter actually got off to a good start, with July and the first weeks of August seeing markets rally.
However, by the middle of August, this began to unwind and a confluence of factors led the markets to
fall throughout September and give up all of the earlier rally.
A similar set of factors have been in play as the markets grappled with stubborn inflation, higher interest
rates and the war in Ukraine. However, for good measure, the ‘mini’ UK budget announcement threw fuel
on the fire, causing alarm across several markets both in the UK and internationally. From a portfolio
perspective, the slight positive in all this was the collapse of the Pound. This caused our overseas holdings
to become more valuable, especially those in US Dollars, helping to cushion part of the subsequent
fallout. Furthermore, whilst we have some exposure to UK equities, the portfolios are dominated by
overseas exposures and so the fallout has been limited.
We have continued with our process of lowering volatility, which we mentioned in detail in the Q2
update. So far, we have timed these well and this time was no different, where we sold out of some of the
higher risk funds in favour of lower risk just as the rally came to an end in August. The funds we sold out
of have since fallen more than the ones purchased.
We would now like to review the previous quarter before moving on to our outlook.
Q3 REVIEW
Market Performance
Year on year US CPI (inflation) did actually fall slightly over the quarter, coming down to 8.3% from a high
of 9.1%. However, some of the core components have not yet fallen leading to the US Federal Reserve
maintaining their hawkish stance and pressing ahead with large interest rate hikes. After briefly hitting
10.1%, UK CPI also fell to 9.9%.
Equities and bonds moved in tandem, rallying during the first half of the quarter and then giving back all
of the gains during the second half. September in particular was a difficult month and ended up being one
of the most difficult since the pandemic falls in March 2020, largely due to the negative rhetoric from the
US Federal Reserve.
When looking at sectors, the weakness was much broader compared with earlier in the year, with all of
the major sectors falling to varying degrees. Health Care remained relatively defensive (in which we have
exposure), however, other defensive sectors such as consumer staples and utilities were just as affected.
Even the energy sector, which has performed well this year, came under pressure.
An area that appears to be weathering the environment is some of the Emerging Market commodity
exporters. With Russia being taken out of the picture, this is creating a tailwind for a number of those
countries. As an extension of this, renewable energy has also performed relatively well. We are
monitoring these and may look to adjust our exposure to the region to get better access.
2022/2023 OUTLOOK
Inflation & Central Banks
Energy and broader commodity prices have fallen recently, helping to reduce the year-on-year inflation
data. However, other components of inflation have been more stubborn in areas such as wage inflation.
This has prompted Central Banks to press ahead with interest rate hikes in the hope that a sufficient
amount of economic damage is done to push inflation down. The US unemployment rate has remained
low despite the backdrop, however, we are now seeing a drop in job vacancies and a slight pickup in
people being laid off and so this may begin to change the picture.
As mentioned in the previous quarterly note, supply chains remain challenged and have been slow to
normalise, particularly due to China’s zero Covid policy. As a result, we are likely to see structurally higher
inflation in the years ahead as the corporate world has had to adjust by increasing prices.
Whilst we expect to see structurally higher inflation, this is likely to fluctuate. We have seen a period of
high inflation and now on a shorter term view, we expect inflation will likely ease due to the very
restrictive monetary policy we are seeing, which in turn should ease the pressures on markets. It is worth
noting though that we are very unlikely to go back to the previous regime of around 2% inflation.
Recession Risk
There has been an incredible amount of talk around the risks of a recession due to the backdrop of
tightening financial conditions. Some signs are there but we have not yet seen a broad array of data
suggesting this is imminent which has surprised many. It does feel like it is a matter of when and not if.
The commodity markets have already fallen to reflect this risk.
Again, as mentioned in our previous note, we believe the markets will finally look 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 a number of our active funds performing better in the
recent past.
This is important because, in the inflationary environment, we have favoured high quality companies,
which are profitable and have pricing power. Whilst their share prices have so far struggled this year, we
continue to believe these types of businesses are best positioned to weather the current backdrop and
that they will eventually come through.
Strategy
As mentioned at the start of the update, we have remained fully invested but have lowered the volatility
levels. We are ultimately investing with a long-term mindset but are conscious of the shorter-term pressures and have therefore adjusted accordingly. Some points to note around our thinking moving
forwards:
- Elevated volatility levels are likely to become a feature of markets over the next few years
and so we will maintain a lower volatility approach. - A key factor this year has been the increase in correlation between different asset classes;
many are now moving in tandem. We have maintained some exposure to areas that have
been less affected outside of equities but are mindful of the attractive yields on offer in the
bond markets. We have been leaning into bonds and may well increase our exposure in the
coming months. However, due to the correlation risks, we do not expect to hold the bonds for
more than 12-18 months and are likely to revert back to better diversifiers. - In terms of our equity allocations, our largest equity exposure will remain towards US
markets. The US Federal Reserve has made good progress in increasing interest rates and we
believe they are now at the latter stages of this process. This could bode well for US markets. - Due to the ongoing war on Europe’s doorstep, we are avoiding any direct exposure to the
region. The knock-on effects, particularly relating to energy prices, are likely to keep Europe
under a lot of pressure. The European markets may well be fine, but it does feel binary at the
moment and a risk not worth taking. - We have some exposure to the UK but given the budget and uncertainty it has created, we
are unlikely to change our allocation for the time being. We are monitoring this closely.
Further budget U-turns could change our thinking. - We continue to hold Asian equities. Whilst this region has come under pressure for generally
different reasons, the backdrop is actually more favourable than many of the developed
markets, where inflation has not been as problematic. Furthermore, the active funds we own
have done relatively well.
Positive Catalysts
To provide some colour on where we see the potential for markets to turn positive, we currently see
three areas; the end of the Ukraine war, the US Federal Reserve slowing the pace of their interest rate
hikes and China developing a Covid vaccine.
It is unfortunate to see the war has continued in Ukraine. This has had a considerable impact on markets
globally, especially from the perspective of higher energy prices as well as the cost of food and other
commodities. It is of course very difficult to predict the outcome of the war, but a resolution would likely
have a big positive impact on markets.
The ‘terminal rate’ is the rate at which the US Fed are likely to pause their interest rate hikes. This is
approximately 4% according to the US Fed and more like 4.5% according to Economists. The current US
interest rate is 3-3.25%. That implies that we could be in the ballpark after the next two or three hikes.
Some US Fed officials have suggested a pause in Q1 2023. The above is dependent on inflation data but
suggests we may be close to some pressure easing on markets.
With regard to China, global supply chains have been affected by their zero Covid policy, adding further
pressures on global markets. However, they have been working on their own mRNA Covid vaccine with
CSPC being the front runner, a Chinese pharma company. Once this is finalised and is rolled out for the Chinese population, we expect this to be a positive for global markets because it should help to ease the
inflationary issues relating to supply side problems.
Summary
Whilst the volatility in markets has continued, 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 as detailed in the update
note, although we are unlikely to make many.
MARKET INSIGHTS – WEBINAR INVITE
If you missed our recent webinar or you would like to revisit it, please click on the recording below to watch at your convenience.
CHANGES MADE
We have made some changes during the quarter. A full account of which can be found below:
And lastly, speaking of the mini-budget…our previous communication announced the abolishment of the
45% additional rate tax. This has since been reversed.
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.
