Great Expectations?

Multi-asset fund manager Will McIntosh-Whyte channels his inner Scrooge as he confronts Christmases Past and Present. Can they provide investors with helpful insights about what’s to come?

By 15 December 2022

Snow has been falling across the country this week, bringing a sparkling white curtain down on 2022. It’s turned the country into a Winter Wonderland for many. Sadly, for others it’s brought yet another miserable chapter in the tale of woe that is 2022. Many can ill afford to turn the heating up, and certainly not to lose earnings because they can’t get to work. The country is on the brink of recession and needs this loss of productivity like a hole in the budget. Adding to my good mood, I had to abandon my car in the snow. And there’s currently a milk tanker sliding precariously down the hill towards my house!

Confronting the Ghost of Christmas Past

This has truly been a year that Scrooge himself would have been proud of. We spent our latest podcast taking David to task on his predictions for 2022. His score may have been somewhat mediocre, but that’s perhaps no surprise given the year’s capacity to keep delivering nasty shocks. (You can listen to our latest The Sharpe End multi-asset investing podcast in full here.) 

When I summon up the Ghost of Christmas Past, it takes me back a year to a Christmas ruined for many by COVID-19. The following 12 months have offered precious little more cheer for investors. The New Year opened with concerns about interest rate hikes. Back then, investors worried about whether economies could handle three or four rate hikes. In retrospect, such fears seem laughable! The US Federal Reserve proceeded to push ahead with the fastest pace of monetary tightening witnessed in recent history, moving its key interest rate from 0% to 4.5% as it tried to tame stubborn inflation. Investor miscalculations at the start of the year about how high rates might go reflect the fact that inflation has been much stickier than expected. Supply chain snarl-ups took ages to thaw, higher house prices fed through into higher rents and labour markets have remained obstinately tight.

Of course, the inflation picture was exacerbated by the terrible war in Ukraine, which sadly continues. As a direct fallout from the war, stiff sanctions were imposed on Russia, which in turn saw gas supplies shut off to Europe. Russia and Ukraine are two of the most important commodity producers on the planet (the latter is known as the ‘bread basket’ of Europe because of its grain supplies). So war-driven disruption forced spikes in the prices of many key commodities. The price of oil moved above $120 and wheat and natural gas prices doubled (with the latter having most impact on Europe and the UK). Many businesses were, therefore, forced to push up their prices to protect their profit margins (and, in some cases, just to stay in business) as their input costs skyrocketed. Obviously, this ended up aggravating the global inflation problem yet further.

On top of this, China – both a key part of global supply chains and the world’s growth engine – spent most of the year in rolling lockdowns while also seemingly intent on raising global tensions over Taiwan. In the UK, politics were rocked by levels of melodrama that even Dickens might have struggled to conceive. And cryptocurrencies and NFTs unravelled faster than a bored ape jumping off a yacht.

The end-result has been falls in the values of most assets as the global risk-free rate was reset. Bond markets were right at the epicentre of the pain, but few asset classes escaped unscathed. Alongside government and corporate bonds, equities, property and gold were all knocked back, leaving very few places to hide. There have been a few pockets of protection, with the dollar proving the most effective shield from global asset class chaos.

Sadly, the Ghost of Christmas Present doesn’t bring much more cheer. The UK is struggling with a cost-of-living crisis, multiple strikes, a broken health service, the threat of blackouts, and an impending recession. (We continue to retain very little exposure to domestic UK stocks.) Europe is beset by many similar woes, including a raised threat of energy shortages. The picture looks a little better in the US, where growth is more resilient and there’s better energy security. But the aggressive rate-rising regime is starting to weigh on America’s economic outlook.

China’s economy has been struggling given its extremely strident and disruptive zero-COVID policy. Its recent easing of COVID restrictions raises the prospect of a welcome fillip to global growth, though the extent to which it can reopen fully may be hindered by the low vaccination rate of its elderly population. Equally, while COVID is still circulating, most places seem to have found ways to live with the virus. Certainly here in the UK, life has returned to a version of events that at least resembles pre-pandemic times. Global supply chain bottlenecks are continuing to ease and inflationary pressures look to be peaking. So perhaps it’s not all gloom and doom!

The positive for investors is that the starting point of asset prices is much more palatable than it was 12 months ago. The yields on government bonds have moved up to levels where they’re now able to resume their role as an important source of protection within multi-asset portfolios when markets shift to ‘risk off’ mode. Starting 2022 with plenty of liquidity was helpful for us, and we’ve spent this year building up our government bond exposure. We accelerated that process in the second half as yields spiked through the autumn –predominantly targeting US duration. Corporate bond yields also look more attractive, particularly if inflation starts to fall back to more ‘normalised’ levels (even if that’s not pre-COVID levels). Again, we added significantly to our exposure in this space (from a low base), as corporate bond spreads widened to levels we felt more than compensated us for associated default and liquidity risks. In particular, we favoured UK subordinated financials.  

That leaves equities, where valuations have reverted to more sensible levels from last year’s lively summits. They are now looking relatively attractive on a medium-term view. We have largely maintained our equity exposure throughout this year, but have been quite active, looking to add equities through ‘risk off’ periods, and trimming into market rallies. More recently, we’ve been adding in particular to some of the structural growth names we own, whose balance sheets and long-term outlooks remain solid. Put options have been useful in helping to dampen the impact of meaningful drawdowns, and we continue to use these tools to help protect portfolios from any further equity market shocks.

Will Christmas Future bring better times?

What about the Ghost of Christmas Yet to Come? Much like in a Christmas Carol, the outlook depends somewhat on the monetary actions being taken in the present. Global economies face mixed growth prospects. If central banks, intent on quashing inflation, drive up rates much higher, growth will get depressed still further. This raises the spectre of disappointing earnings, leaving equities vulnerable to further downside. But inflationary forces are waning. We head into the holiday season with commodity prices likely to start 2023 materially lower than where they spent much of 2022. House price growth has stalled, and rent pressures are slackening. The labour picture appears more mixed, though slower growth is likely to curtail wage demands and prevent inflation expectations from racing away. This could give central banks some breathing space. If they pause, this should allow economies and companies alike to adjust to the new higher rate environment.  

Finally, the future looks a little brighter this week with the news that scientists have made a breakthrough in nuclear fusion energy - a big step towards producing abundant cheap and clean energy. It may still be a long way off, but it can’t come too soon, and would finally consign coal only to the stockings of the naughty. It could, of course, also leave renewables investors with a ‘stranded assets’ problem, but I’ll save that miserly discussion for another year!

Tune in to The Sharpe End — a multi-asset investing podcast from Rathbones. You can listen here or wherever you get your podcasts. New episodes monthly.

We are taking a festive break and will be picking up the pen once more on 9 January. Happy holidays!