It would be no exaggeration to say that the first month of 2022 has been eventful. Inflationary concerns, central bank tightening and increasing tensions in Eastern Europe have all been shaking the markets since the start of the year, increasing volatility and resulting in significant sell-offs in certain stocks.
Although geographically the emerging markets outperformed their larger brethren last month, it was the rotation out of many of the growth stocks that attracted scrutiny, as investors began fretting about some of the lofty valuations attached to some of those companies.
The NASDAQ indices, populated by technology stocks, narrowly avoided their worst ever start to a year. The S&P 500 index, meanwhile, suffered its worst month since March 2020, and its weakest January performance since 2009.
At the end of the day, interest rates will need to rise – regardless of what happens with inflation.
The economy now appears to be dealing with embedded inflation – at least for the foreseeable future. Higher wages and rising prices on a variety of goods and amenities (including food and energy) are now an inevitability. This will put stress and pressure on both consumers and businesses.
What this means is that companies which promise future growth but currently generate negative cash flow are vulnerable to selling pressure. Meanwhile, robust businesses with intelligent working capital, positive cash flows, a balanced capital structure, income-generating assets and the ability to pass on pricing pressures are better positioned to weather this period of high inflation and rising interest rates.
Sectors such as oil and gas would normally provide some sort of protection during periods of higher inflation. However, since they have had to invest so aggressively in infrastructure, prospection and exploration, they have been less successful at ensuring effective use of that capital.
A shrinking supply of reserves have combined with rising political tensions in Eastern Europe to push up the price of Brent Crude oil in recent times – the current price of US$90 a barrel is the highest it’s been since October 2014. This is remarkable when you consider that barely two years ago, the US benchmark West Texas Intermediate Crude Futures made history by trading and settling in negative territory.
Alternatively, while index-linked bonds are designed to keep pace with inflation, they could now prove to be a somewhat costly inflation hedge: investors have been piling into inflation-linked assets, pushing prices up.
Investment Quorum’s preferred methodology is a three-silo investment approach: we seek to invest in great companies with global reach that pay dividends out of profits and drive innovation. Innovation is likely to be more deflationary than inflationary, and a total return strategy (growth and income) is a very powerful combination for generating investment returns over longer time horizons.
Ever since the US Federal Open Market Committee announced that it would be buying a substantial quantity of US Treasuries and agency mortgage-backed securities in a bid to stabilise the markets during the pandemic, the so-called Fed watchers have been trying to predict when the US Central Bank might begin to withdraw its support and normalise US interest rates.
With inflation rates rising to levels not seen in decades, investors have been bracing themselves for choppier waters ahead. In its recent statements, the Fed has been voicing growing concern over inflation. This in turn has given the market grounds to believe that from March 2022, the Fed will start announcing interest rate hikes on a regular basis.
Moreover, US futures are now predicting interest rate rises of up to 1.25% for 2022 alone as a way of alleviating some of the recent effects of inflation.
In the UK, the Bank of England has raised its inflation forecast – it is now thought that it will peak at 7.25% in April. This led to it raising interest rates twice in quick succession – the first pair of back-to-back rate hikes since 2004. The message it is sending out is clear: we can expect a gradual normalisation of UK interest rates. The rate currently stands at 0.50%, while the labour market remains robust.
With rising interest rates and slower growth to contend with, there can be no doubt that choppier waters lie ahead of us. We can expect inflation and supply chain disruption to continue throughout this year. We remain committed to our current investment strategy and positioning, and our focus is very much on the longer term.
