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March 2022 Mid-Monthly Update

Imbalances

While previously the biggest impact on financial markets were inflationary concerns and monetary policy responses as Covid ebbed, Russia’s invasion of Ukraine on 24 February has taken top spot for financial markets’ concerns and nervousness.

 

We have no great insight on when or how that conflict will be resolved so we will refrain from adding to the wealth of opinion you are already exposed to.

 

 

Supply

Already suffering from supply shortages from labour to semiconductors, markets now have to contend with supply disruption on energy and foodstuffs.  The already high inflation rates in western developed economies look like they will go higher but for how long?  We don’t know, neither does anyone else including the central banks charged with administering monetary policy in order to keep inflation close to 2% per annum.  It is likely that inflation will be a multiple of that for a while.  As central banks attempt to ‘normalise’ monetary policy, they face the quandary of raising interest rates in a slowing economy.

This week will probably see interest rate increases of 0.25% in the US Fed Funds rate and here in the UK through base rates. Seven such increases are priced into US interest rate futures for 2022.

 

Demand

The offset to a supply shock is to engineer a reduction in demand which is less easy to do when the labour market is so tight and unemployment is low. Many financial market commentators have compared the current scenario to the events of the 1970s when unionisation of the UK labour market was around 50% of the labour force.  Today it is just under half that, but many employees will be seeking higher wages to compensate, in part, for the higher cost of living which has dented disposable incomes. The wages/cost spiral is one that central bankers fear. Evidence suggests that economic growth is slowing and already was before 24 February’s unprovoked events.

The usually excellent Atlanta Fed estimate for Q1 2022 US GDP is only just above zero, having dipped into negative territory post Russia’s invasion of Ukraine.

 

Adding weight to the slowdown argument in the US is the recently released University of Michigan survey on consumer sentiment sourced from The Daily Shot:

 

The weakness in both consumer sentiment and expectation indices is attributable to rising fuel prices. They could go higher; fuel prices that is.

 

Balance

 

Trying to maintain a balanced portfolio isn’t easy especially when most bonds, save the safe-haven bid that flickered post invasion, are the wrong price – their yields are too low.  Credit markets have been tricky to negotiate with spreads generally wider.  Even after inflation has risen before potentially moderating, negative real yields are not compelling for investors other than to avoid them.

However, it is not a bad idea to buy assets for which demand is greater than supply.  Commodities fit that bill and while undoubtedly volatile, may be a better balancing asset class against equities than bonds of any kind.  As the following chart sourced from Bloomberg illustrates, commodities look cheap against (US) equities historically.

In equities, those companies with the ability to be price makers should have the upper hand.  It was noticeable in a topsy-turvy month to date for asset prices, not least the huge up day in equity prices on 9 March, that those companies who are financially robust but caught up in the growth equity sell-off chose to use their large cash balances to buy back stock. Amazon’s US$10 billion share buyback programme is an example.

 

Your Money

Activity in March to date has centred around commodity exposures. We have maintained a significant position in industrial metals but have taken some profits when prices looked stretched.  We have also broadened our commodity exposure by including an agriculture ETC recognising that essential food supplies, notably wheat, have been disrupted by recent events.

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