Global equity markets had a strong 2021 with a total return of 22.94% for the MSCI World index. Since then, global equity markets have had a tough start to the year and the MSCI World index has fallen -6.50% between 31st December 2021 and 15th February 2022. Rising inflation, concerns about tighter monetary policy and tensions between Russia and Ukraine have influenced markets and led to a sharp increase in volatility.
The Bank of England has already started tightening monetary policy with interest rate increases in December 2021 and February 2022 taking UK interest rates to 0.5%. Further increases this year are possible, depending on inflation data. Additionally, the US Federal Reserve is likely to begin increasing interest rates soon, following news of a 7% increase in year-on-year inflation in December 2021.
This backdrop has led to a rotation out of interest rate sensitive “growth” stocks in sectors such as technology into “value” stocks. These are companies that have been trading at a lower level than their actual intrinsic value and include energy companies or banks. As a result, the large US technology stocks which had led the market during the pandemic had a significant price correction in January. The “stay-at-home” stocks that attracted a lot of interest during the pandemic like Netflix and Meta (Facebook) were particularly affected. We reduced exposure to these stocks in June last year through the sale of the iShares S&P 500 ETF, switching into a more valuation focused, actively managed fund, which invests in US companies of all sizes and has some exposure to bank, industrial and energy stocks.
Following the pandemic, we continue to expect economic re-opening and reflation in 2022, which should be broadly positive for equity markets. This view is based on the high vaccination levels in developed markets and increasing vaccination levels within large economies such as India and China. Our overall approach is to ensure that the equity component of our model portfolios has exposure to a range of investment strategies and has an allocation to areas such as financials and energy. These sectors have the potential to be positively influenced by rising interest rates and commodity prices respectively. The larger energy companies are also expected to be involved in longer-term energy transition away from fossil fuels.
We have recently made some changes to the international equities exposure within all our model portfolios with the introduction of two more value-focused funds in the Cautious-to-Balanced, Balanced, Balanced-to-Adventurous and Adventurous portfolios. Additionally, within the Cautious and Cautious-to-Balanced portfolios we have increased the exposure to global equities by 5% as we anticipate a broad-based global economic recovery. We also retain some exposure to “quality” stocks where the companies have pricing power and can pass on input price increases to consumers.
Rising interest rates and inflation have created a more challenging environment for traditional bond funds investing in longer-dated debt. UK and US government bond yields rose in January, meaning prices fell, as the market priced in the potential interest rate increases to combat higher inflation and the implications of the Federal Reserve winding down its unprecedented levels of quantitative easing. We have made some changes to the model portfolio fund choices within our Cautious and Cautious-to-Balanced portfolios, switching to more flexible fixed interest funds which can invest across the fixed interest spectrum and which have a lower duration i.e. interest rate sensitivity. This is considered important in an environment of higher inflation and where interest rates are expected to rise incrementally over the year.
This article is for information purposes only. It does not constitute investment advice and is not a recommendation to invest. The value of investments and the income from them may go down as well as up and you may not get back your original investment. Past performance is not a guide to the future.
Date of publication: 17 February 2022
