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As world markets inch steadily higher the most common question we are asked by investors is so, what can go wrong?
It is easy to understand these concerns – after all, we have seen five months of back-to-back gains in stock indices, equity volatility that is plumbing new post-Covid lows and US Treasury yields that have fallen below 1.5%, while inflation measured by consumer prices is still rising by 4-5%.
For now, markets, it seems, are discounting every piece of good news and more. June’s big worry for example, that the Federal Reserve was ‘behind the curve’ on inflation has, after some deft communications from Chairman Powell, soon been forgotten. Powell managed to bring forward forecasts of US rate rises to 2023 and talk openly about tapering asset purchases later this year, with barely a murmur from either bond or equity markets.
Political risks too are perceived to have fallen – President Biden has all but inked a bi-partisan infrastructure deal and quickly brought America’s allies on board at the G7 summit. Even the worryingly infectious new variant of the virus seems now to have had its worst effects mitigated by vaccination. The good news keeps coming, so what could be around the corner?
Yes, the world is a much rosier place than it was sixteen months ago, but underneath the optimism, there is much still to consider. Industries across the world signal extreme pricing pressures across their supply chains. In both the US and UK, we are hearing that labour supply is increasingly sticky, with working parents and retirees particularly reluctant to re-join the regular workforce after Covid absences.
This is putting upward pressure on labour rates for new recruits, which could easily spill over into the wider workforce (on a positive note I should add, many of these wage gains are at last accruing to the lowest paid). Meanwhile, political challenges with China continue to rise on a number of fronts. The Biden White House is probably even more hawkish here than Trump’s administration, just as tensions with Taiwan are again rising.
On an investment level we have been acutely aware of risks and have been managing our portfolios accordingly. Markets have always taught us that you need some concerns to offer attractive investment opportunities and it is an often-used phrase that “markets like to climb a wall of worry”. As bonds have been volatile this year, we have used other assets at our disposal, such as commodities and infrastructure, to diversify portfolios. In other words, we have plenty of tools to harvest opportunities – but managing the risks is always a key area of focus.
For investors the problem is clear – aggressive financial easing by central banks has effectively debased many of the traditionally defensive assets. Meanwhile, there is a dearth of other alternatives; cryptocurrencies offer too many regulatory and ownership hurdles, while gold is potentially attractive, but portfolio position sizes are probably limited due to volatility on the asset class. There are fewer places left to hide as central bank liquidity has now floated most of the boats, however the investment team continue to work hard to build a strong margin of safety in our portfolios and we are confident in our ability to defend, as well as participate in what we expect to be a continued recovery, especially in UK Equities.
As we enter the main part of the summer holidays, we will take a short break from our weekly update and I look forward to writing to you again on the 3rd September. Overall, it has been a pleasing year to date for our clients’ portfolios and we look forward with renewed confidence for what is in store between now Christmas. As always there will be some surprises along the way, but I am sure that we will be able to deal with them and, you never know, they may be good surprises after what has been a difficult and volatile last sixteen months. Thank you once again for your trust in the services we provide and please do enjoy the rest of your summer.
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