27 Jul 2022
It may seem like a strange question, but why should fund managers continue to pay attention to third-party investment strategists whose views have not worked out as expected?
First, there is a question of time – what may appear wrong today might be right tomorrow. Secondly, one should always try to understand the arguments for a particular view. The conclusion drawn may be wrong, but the thought process may be illuminating. Third, humans are good at rationalising, determining that an outcome was obvious, which then becomes orthodoxy and leads to ‘groupthink’.
I am always keen to read the views of Albert Edwards, who is by far the most interesting investment strategist in the UK. His pieces are always full of challenging ideas, with a liberal smattering of references to other peoples’ work. I find myself looking up research articles that are highlighted – for readers of my generation a bit like a TV programme hosted by James Burke called Connections – leading to some great challenges to the rather mundane research pushed out by most big banks.
Such an argument is whether money supply (not talked about so much these days) is the real cause of inflation and that, given the surge in narrow money as a result of Covid measures, interest rates will need to be raised further to engineer a recession. The problem facing the US Federal Reserve is how to bring about a ‘soft landing’. Given cheap money for 15 years, there is a fear that even raising US rates to 3.5% will reveal financial excesses (crypto and housing) that will be hard to control on the downside.
You don’t have to adopt the pessimism that can result from following these views, but it is a salutary reminder that there are a lot of outcomes possible from where we start today. It is one reason I have pulled back on my long-held bearishness on 10-year gilt yields.
On the subject of groupthink, when UK authorities were scenario planning for negative rates two years ago, I wonder how many of us contemplated UK inflation at 10%. Well, last week’s figures showed the old inflation measure Retail Price Index (RPI) at 11.8%, with the favoured Consumer Price Index (CPI) coming in at 9.4%; core CPI was in line with expectations at 5.8%. The main drivers of the rise in headline inflation were food and petrol/diesel prices, with the infamous second-hand car price surge seemingly now abating; the largest downward drag was from clothing and footwear. Food prices have become a key driver of the current spike, with the highest monthly increase since 2008.
So, what should the Bank of England do? It will put up rates and hope that the base effects of higher energy prices reduce inflation data in the new year. It will also hope that a slowdown will entice the ‘lost workforce’ to return. Market rates imply 2.75-3% for official rates in 12 months. This will be bad news for consumers as real pay falls and mortgage rates increase. It is hard to see the government, under a new leader, not doing more on the fiscal side to ease the pain.
Government bond markets were in a bullish mood last week. Ten-year US yields moved to below 2.8%, having been at 3.5% in mid-June. The UK was not left out with the equivalent yield moving below 2%, 70bps below its recent high. Despite the recent surge in inflation, implied inflation has been trending down; since mid-April, long-term inflation expectations, as derived from markets, have fallen by 60bps in both the US and UK. There was a significant move from the European Central Bank (ECB) last week, with a 50bps rate hike. However, this did not stop a rally in German yields that saw the 10-year yield move towards 1%, compared to 1.77% seen just four weeks ago.
Credit markets recovered with both investment grade and high yield spreads tightening on the week. My favoured high yield measure saw a 45bps move lower and, although the shift in investment grade was smaller, sentiment was undoubtedly better. Looking at valuations, credit looks attractive to me, despite the darker clouds on the economic horizon.
As someone who was enthralled by the Coe/Ovett/Cram rivalry, it was great to see Jake Wightman win the 1500m at the World Athletic Championships. Sometimes outcomes are too fanciful to contemplate: who would have thought a father would commentate, as stadium announcer, on his son’s gold medal run at a major world event?
Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.