Investing with Conviction
22 April 2022
To all Financial Friends
Commentary and consideration for a current conviction portfolio.
Markets have recovered from the 2008 credit crunch. However, the knock-on effect has been to increase global debt leading to quantitative easing (equivalent to printing money) and maintaining low interest rates. This has been needed to support the global economy and prevent the near collapse of capitalism.
Such strategies have been necessary but have had the effect of preventing historical market forces operating in a textbook traditional pattern.
This form of entrapping normal markets cannot continue indefinitely. The global economy cannot thrive under such conditions permanently.
As hopes for continuing stability emerged, Covid arose increasing the need for economic stimulus. Hence more quantitative easing and greater indebtedness in the economic system.
The strategies employed created the opening for inflation to increase (now heading for 10%). This increasing threat is worsened by distribution problems (Brexit, Ukraine and Covid) creating shortages of goods increasing inflation above expectations
Putin’s war against Ukraine is now in its tenth week and may reach a settlement, be fought out over a protracted period, or lead to the 3rd world war. In the event of a 3rd world war considered expectations are that this would mean nuclear confrontation.
As (and if) expectations of worsening war potential do arise investors will fly to safety. This most likely will mean the sale of equities while investors seek safer investment holdings.
Funds will flow into governments of the established nations. Inflation will continue due to shortages of materials and basic living provisions.
In these perilous times resting funds against the apparent security of government resources will ultimately provide the greatest place of safety. Inflation linked government bonds/gilts could provide a protection against inflation.
Supply and demand will cause government inflation linked bonds to rise in value creating a capital gain for investors. This, while equities and fixed interest bonds (those with non-inflation linked yields) could be expected to suffer the greatest losses.
However, even government bonds, non-inflation linked could be sort after as a last resort.
Demand normally pushes up the price providing investors with capital gain.
For Investors With Expectations of Increased Economic Pressures
Please remember that in all market conditions there are always opportunities for profit.
In addition to war threat the global and UK economies carry other risks. For example:
A repeat of, or the continuing effect of COVID as people and economies adjust to living with it.
The concern of inflation continuing to move out of control. The main method of controlling inflation is to raise interest rates. This slows the economy as costs rise and demand for products and services reduces. Lower demands from consumers prevent providers from raising prices thus slowing inflation down.
Authorities have to finely balance the raising of rates. Raise rates to slowly and inflation will rocket further. Raise rates to quickly and the economy will be dampened down too far.
(Social unrest can be caused by either of these extremes).
We are already in a period of stagflation where people’s incomes/salaries remain level while costs are rising. Sales in shops (retail) last month fell by 1.4% probably as a result of stagflation.
Political tensions between nations continues with potential economic considerations.
Distribution of goods and materials are already causing concerns for industry and even our supermarket shelves. The causes are COVID, Brexit and the effects of the war Russia/Ukraine. The effect again is rising costs /inflation and upon business as materials do not arrive or are delayed.
The growing concerns over global warming and the opportunities/threats that are affecting investors considerations.
The following understanding may help you in your consideration for future portfolio holdings reflecting the above issues:
Government inflation linked bonds – for the reasons outlined above.
Gold and precious metals – investors buy gold and push up the price in times of fear and uncertainty.
Global Infrastructure Funds – Funds that invest in shares of companies that build roads, hospitals railways etc. Even longer term (sadly) the need for the rebuilding of war-torn cities. The UK and the US have already set huge sums of £sterling and dollars aside to plough into infrastructure. As a class this is a defensive sector and may not correlate (fall) with other assets that may fall in value.
Consumer Staple Funds – These funds invest in the companies that produce and provide the everyday things we have to buy – like it or not. As disposable income shrinks against rising prices our money is restricted to buying the basic necessities for life. These funds also may not correlate but go against the downward trend of other equity investments in times of recession and financial stress.
Alternative Strategies
What if authorities across the global spectrum succeed in combatting or reducing the severity of the issues above? Is your cup more than half full? Then this could reasonably be your conviction.
Looking at the chart of performance of the spread of investments used by students with your financial friend this is what we can see.
Some students have held portions of their funds across UK and American Equities including an emphasis on technology and for some, specialist funds individually selected through each individuals choice and research.
My commentaries over recent months have indicated a preference for Inflation linked bonds, Gold and precious metals and infrastructure funds. This was foreseeing troubling developments ahead, in line with the points made in the above paragraphs.
A one year chart to date shows that Gold and Infrastructure have outstripped the performance of equities over the year and especially since 1st Jan to date. Inflation Linked Bonds have surprisingly lagged behind though show very recent signs of recovery.
If you believe the challenging issues raised above could be manged well and the threat of war does not further increase, then equities should rebound strongly. If this is your view and you are holding equity funds you may consider that you would do well to stay there.
Remaining in equities if affairs are not managed well and/or war develops negatively, it is expected that the main body of equities could fall steeply.
PLEASE NOTE: A financial or economic commentary like these, are written to explain, interpret or give an opinion on economic events and markets to help readers understand what’s happening and why it matters. Designed to help you make informed decisions of your own by making you aware of opportunities, risks and potential rewards in the market.
