By Thomas Becket, CIO, Psigma Investment Management
The start of the year has seen falls across most asset markets, with the combined world stock market down 4.6% and the UK government bond index losing 3.9% in January. We have also seen a major reversal in the fortunes of the recent leaders and laggards, with the previously omnipotent US market shedding 4.5% in January, with the much-loved Technology sector down much further, whilst the UK FTSE All Share “only” lost a much more respectable 0.3%.
Volatility is an investor’s friend, not their enemy
Whilst volatility is “nerve-wracking” for investors, this is all part of a normal market cycle. What we saw last year, both in terms of the extraordinary confidence from investors and a managed market calm by central bankers, was abnormal. Our key message has always been to treat volatility “as a friend and not an enemy” and this philosophy will be key in 2022. We have been using the recent turbulence in markets as an opportunity to recalibrate our investment strategy and increase exposure to certain investments that have been unfairly treated.
The “Pandemic Trade” is now over
What we are now seeing across global asset markets is what we forecast towards the end of last year, which was detailed in our recent “Five Themes for 2022” update. It became clear in mid-2021 that markets had become increasingly dislocated from the reality of a near future that heralded slower economic growth, reduced potency of corporate profits growth, elevated inflationary pressures and, clearly most importantly for now, a marked change in both central bank attitudes and the environment for liquidity. Admittedly, what we didn’t expect was that markets would carry on partying like it was 2020 in the last few months of last year, with some unexpected performance from specific investments. Maybe that was the “last hurrah” of the pandemic trade, but whatever it was, it appears over now. Previously favoured “growth” shares and government bonds have been hit woefully hard at the start of this nascent new year, with the darlings of yesteryear down materially. At the same time, there has been no solace in the supposedly protective high-quality bonds and the widely held duration-sensitive instruments, with new cycle highs in bond yields, new cycle lows in bond prices and some concerning performance. We are pleased to report that we have been positioned for these dynamics and have been able to protect against the worst of the losses experienced across major bond markets.
Central Banks bare their teeth
The causes of this onset of market troubles are the Central Banks and the growing concern over inflation. Over the last few weeks, we have seen a clear determination from Central Banks on both sides of the Atlantic to raise interest rates and act aggressively to curtail inflationary pressures. This is a major change. As a guide, the UK Monetary Policy Committee is now expected to raise interest rates another five times further, following on from the two recent increases, implying that UK interest rates will end the year at 1.75%. The significantly more important US Federal Reserve is forecast to act similarly.
A “regime change” dawns across markets
The ramifications for investors from this new-found determination from Central Banks are severe and imply a market “regime change”, as we have been suggesting. Notably, parts of global asset markets that have been hugely inflated due to the loose monetary policy and investor complacency have been hit especially hard at the start of this year and the Central Banks have not softened their tone. Indeed, they have become even more resolute in their rhetoric. The question that we and all other investors should be asking ourselves is, how much market pain Central Banks are willing to take? Will they, as they have on every previous occasion since the Financial Crisis of 2008, back away if markets continue their recent declines? We can’t answer this question definitively, but the difference here is inflation and the miserable impact it is having on the lower earners in society, as Central Bankers and politicians are finally admitting. Maybe, just maybe, the Central Banks will not ride to the rescue of investors this time.