After more than a decade of low interest rates and restrained inflation around the globe, many goods and services prices have increased rapidly and interest rates are being raised incrementally in the UK and US in a bid to contain it. The US Federal Reserve raised the interest rate by 0.75% on 15th June, the first hike of that size since 1994. That puts the interest rate in the target range at 1.5%-1.75%. The following day the Bank of England raised interest rates by 0.25% to 1.25% in response to living costs rising at the fastest annual rate for four decades. UK Inflation is forecast to peak at 11% in the autumn, driven by soaring energy prices. 2022 started with the expectation of strong economic growth in many developed economies as they re-opened following the pandemic. However, this is now in the balance as Central Banks tread a very difficult path to contain inflation without triggering a recession.
The backdrop for bond markets continues to be challenging as a result and broad fixed income market indices are in negative territory in the year to 21st June, with the Investment Association Sterling Corporate Bond Index declining 13% in this time period. We switched into two new bond fund selections in February within our Cautious and Cautious-to-Balanced portfolios to tap into their lower duration, a measure of interest rate risk. Both funds have outperformed the Investment Association Sterling Strategic Bond sector in relative terms between the investment date of 15th February and 21st June. The fund returns are -2.65% and -2.91% compared to a decline of -7.18% for the Investment Association sector. Whilst we have reviewed alternative investments for a portion of our fixed interest allocation, we have yet to find any fund which would meet our strict valuation, fund size and liquidity criteria and we do not wish to “chase performance” and move into overvalued assets. Buying an asset when it is overvalued/expensive can greatly limit the potential for long term returns.
The FTSE 100 has continued to be the best performing major developed market equity index between 31/12/2021 and 21/06/2022 with a total return of -1.25% and has held up relatively well due to its exposure to financial services companies and energy/mining companies which benefit from rising interest rates and rising commodity prices respectively.
US markets have been pricing in an inflation rate of 8.6% in May and concerns that higher interest rates could tip the economy into recession. The S&P 500 fell -12.45% in Sterling terms in the year to 21st June. Additionally, large technology stocks have seen a significant decline in prices in the year to date. Meta (formerly Facebook) took a $230bn hit to its market value in February 2022, Apple is no longer the most valuable company in the world, and the S&P 500 Information Technology sector is down -19.28% in Sterling terms in the year to 21st June. We reduced exposure to US technology stocks in June last year, switching to the Premier Miton US Opportunities fund, which invests in US companies of all sizes and has a strict process centred upon avoiding investment in overvalued companies.
We have recently had in-depth discussions with fund managers regarding the outlook for China. China now accounts for 30% of the MSCI Emerging Markets index based on market capitalisation and has long produced economic growth way ahead of that achieved by developed economies in the west. However, the combined effect of the US-China trade war, regulatory crackdowns and recent hard lockdowns to contain COVID outbreaks in major manufacturing and port cities have caused volatility in Chinese equity markets. The CSI China Securities 300 index has declined -7.46% in the year to 21st June. In October last year we switched to the Jupiter Asian Income fund within our Balanced, Balanced-to-Adventurous and Adventurous portfolios. This was to reduce exposure to China within these model portfolios because the fund only has 1.6% exposure to mainland China. Exposure to mainland China within these portfolios via our Asia Pacific and Emerging Markets fund selections is now in the range of 1% – 3%. Between October and 21st June 2022 the Jupiter Asian Income fund has returned 7.23%. We are comfortable with the remaining exposure to China within portfolios because it is focused on areas such as technology, including semiconductor manufacturing, solar panels and electric vehicles and their components; all areas which we consider to have the potential for long term growth.
To conclude, the year to date has proved challenging for both equity and bond markets. We continue to remain focused on the potential for long term returns within our portfolios and remain invested because it is near impossible to time market exit and re-entry correctly and it has the potential to create further volatility for portfolios and to impact longer term returns.
This article is for information purposes only. It does not constitute advice and is not a recommendation to invest. The value of investments 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.
The information in this article is correct as at 27 June 2022
