Our latest blog extracts a recent article by Michel Perera from Canaccord Genuity Wealth Management, a very popular asset manager among our clients. Here we can read Michel's insights into the prospect of global inflation and the implications this may have for your portfolio.
 
Markets have not been straightforward this year. On the surface, equity indices are positive; underneath, swan-like, there has been a lot of action with large differences in performance between growth sectors (healthcare, technology) and value sectors (energy, materials, financials). This has given the impression of massive drops in certain sectors and the word ‘tantrum’ has been revived from the 2013 ‘taper tantrum’ episode. In 2013, markets were concerned that the US Federal Reserve (Fed) would stop buying assets (mostly US Treasury bonds) from the market. As a result, the whole bond market repriced with a ricochet slump in equities. ‘Tantrum’ has therefore come to be associated with a market correction. 

Why are markets concerned about inflation? Current market worries come against the backdrop of fears of surging inflation. But are these worries overdone?

Last year, at this time, the pandemic caused inflation to collapse all over the world, setting a very low comparison threshold for this year’s prices. Inflation is generally measured as the rate at which the prices of goods and services bought by households rise or fall over 12 months, hence the starting point matters enormously. Plus, as a result of lockdowns, partial re-openings and supply chain issues, many bottlenecks have emerged which will inevitably cause certain prices to rise. It doesn’t take much more than that for the market to expect soaring inflation - and hence the prospect of the Fed stemming it by raising interest rates.

What is the Fed’s outlook for interest rates and inflation?

While the Fed has steadfastly confirmed that it will not raise interest rates for years (2023 at the earliest), it has not ruled out tapering its asset purchases (at this stage, they think there is enough liquidity in markets and don’t necessarily want to add more), which is why a tantrum is feared. Given that government bond yields have soared this year, from 0.9% to nearly 1.7% for the US 10-year bond (and from 0.19% to 0.82% for the UK 10-year gilt), markets are concerned that the Fed reducing its purchases will mean yields soaring further - and a bigger correction in equities.

Even last week, Fed Chair, Jay Powell, re-stated that interest rates will be on hold for at least two years and that short-term spikes in inflation will be tolerated, as the Fed doesn’t believe that higher prices will stick for long. His explanations have been very clear but nevertheless are not believed by markets who persist in believing that a string of high inflation numbers will trigger higher interest rates much sooner than the Fed indicates.

The Fed’s inflation gauge - the Core PCE (Personal Consumption Expenditures) Price Index - has been consistently below the Fed’s target of 2% during the whole of the last economic cycle, with a couple of brief exceptions. Chair Powell has announced that, from now on, the inflation target will not be an absolute number but an average number over a long period. Given that Core PCE has lagged its 2% target for 12 years, the Fed is saying it would be willing to wait for a few years with inflation above the 2% target before stepping on the brakes. Once again, markets are unconvinced and look for signs that a spike in prices will cause an interest rate hike soon.

Is the Fed’s interest rate policy likely to be reversed?

It is inevitable that we will see some nosebleed inflation readings in the next few months, but unless they are sustained for the whole year at least, it is unrealistic to expect that the Fed’s interest rate policy will be reversed so soon after announcing it (the last Fed policy lasted 40 years). Will markets pay attention to what the Fed says and does, or will they keep expecting the worst? Eventually, markets will get the message, but there could be some moments of extreme concern caused by inflation tantrums.

What can investors do if there is a market correction due to inflation concerns?

Anyone underinvested may want to consider purchases of risk assets like equities. Why? Simply because we have never seen the current favourable alignment of planets in the investment world:

• Loose monetary policy for years regardless of inflation levels
• The largest level of fiscal stimulus since WWII
• Individual investors sitting on the largest cash balances seen in decades
• Companies also enjoying the healthiest balance sheets in decades
• Vaccines now available to start taking us all out of lockdowns.

If the Fed is not going to raise interest rates, then the backdrop is the most conducive in many economic cycles.

What if inflation does indeed take off?

Of course, investing is not just about having a view, but also about preparing for alternative scenarios. There are several ways to help protect an investment portfolio from rising inflation:

1. Equities are generally the asset class of choice when inflation rises, as companies can generally pass on their costs more easily (with some value sectors likely to benefit most)
2. Inflation-linked bonds can offer better protection from increased inflation
3. Gold and certain commodities (industrial metals, energy) are also generally geared to higher prices. These investments can be woven into a balanced investment portfolio meaning an inflation spike need not be wealth-destroying for investors.

A bull market, where equities are rising and expected to continue rising, has often been said to ‘climb a wall of worry’, as many market participants fear something will go wrong. In this case, it seems that the market is already bent on anticipating tears at the end of a cycle which has only just begun. Markets don’t believe central banks when they say rates are not going to rise soon. Yet, historically, it has paid off to heed their words. ‘Don’t fight the Fed’ is the best-known Wall Street adage. Maybe we should listen more carefully.

By Michel Perera
Chief Investment Officer at Canaccord Genuity Wealth Management

Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.

The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.

This is not a recommendation to invest or disinvest in any of the companies, funds, themes or sectors mentioned. They are included for illustrative purposes only.

The information contained herein is based on materials and sources deemed to be reliable; however, Canaccord Genuity Wealth Management makes no representation or warranty, either express or implied, to the accuracy, completeness or reliability of this information. All stated opinions and estimates in this document are subject to change without notice and Canaccord Genuity Wealth Management is under no obligation to update the information.
 

​Even the most seasoned of investors become uneasy when the markets fall and September 2020 has seen quite a deep sell-off after the extended recovery from the bottom of the markets in March. Tech stocks overheated and have now returned to more reasonable valuation levels but should this September correction concern you and what lies ahead?

Many investors have short memories and are often influenced one way or the other by recent events as opposed to focusing on the longer term picture which every investor knows deep down, is the pragmatic approach and the key to successful returns. Market sentiment is often infectious and the sheep will follow the bears or they will cling to the tails of the bulls. Not something Warren Buffet would subscribe to! Successful investment strategies are achieved by looking at the long-term of multiple years, not what has happened in the last 12 months or what they are anticipating might happen in the next few months like the effects of a US election.   
 
History tells us that for the vast majority of the time, US elections do not have any great effects on stock market returns in those respective years. Therefore do not allow the timing of the election to have a big sway on your decisions to invest in your long-term goals because you don’t stand to gain much by waiting for the election to conclude.

If you camp with the bears, check your portfolio risk and ensure you have some exposure to more defensive assets like cash or bonds but don’t eliminate your investment in stock-based assets like mutual funds, ETF’s and direct shares in companies.  Your cash and bond exposure could be a counterweight to your retained positions in equity-based investments which should always represent a percentage of your portfolio.

The key during any periods of stock market volatility is to remain disciplined, do not panic, and constantly remind yourself of your long-term goals. Don’t lose sleep over how the stock markets might perform over the next 6-12 months and keep focused on that goal of a comfortable retirement or the best college for your kid’s education.

However if you have reasons to need access to capital in the short-term, remember that typically, bear markets tend to last about 2 years so if you need liquidity within that timeframe, your best bet is to adopt cash positions as there may not be sufficient time for risk-based assets to fully recover. 
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Have you checked the risk level in your portfolio recently? Does it need rebalancing? Talk to your investment adviser and check if your positioning is right for you and your long-term goals.    

Crystal clear water, skies of the deepest blue, air so fresh you want to bottle it. Places like this are usually only found in a tropical paradise but during the lockdown with the global population restricted to working from home, we have allowed the world's eco-systems to 'breathe' again. Amazing what can be done to help the environment, even if it was so tragically forced upon us. 

Even before COVID-19, global warming, the environment, and the policies of ethically run companies, had become topics of hot debate among many people the world over. So much so that companies now realize they need to display a strong awareness of, and have a coherent policy for 'ESG' to attract and retain employees and stakeholders alike.

ESG means 'environmental, social and governance'. Companies with strong and clear policies surrounding these issues are set to get ahead, and many people believe, stay ahead.

But what does this mean for the individual investor? More and more clients are asking us for ways in which they can invest in the ESG sector, be that for capital growth and/or they simply believe in ESG and wish to be a part of it for moral reasons.

So which sectors could be hotspots for ESG investing in the future? One of the most obvious is water and with global warming, it is becoming an increasingly scarce commodity. Companies involved in good water management and clean water processing could be set for strong growth. Also, companies committed to clean and renewable energies and de-carbonization may attract more stakeholders in the future and alongside them, companies involved in the evolution of electric vehicles and the batteries that power them.     

Of course, purchasing individual shares in companies is always a risky strategy, even more so in specific sectors. Should you wish to do so, we would recommend no more than 10-15% exposure to ESG in any investment portfolio. Alternatively, due to the rising demand for ESG-related investments, more and more collective investment schemes like mutual funds and ETF's with a specific focus on investing in stocks of companies with a strong ESG identity, are coming to the market and a number of them offered by some of the world's largest fund houses. Collective investment schemes typically invest in a basket of 30-40 stocks which diversifies your risk.   

This article is not a solicitation to invest in the ESG sector, it is simply for your general information.  Oh and while we are on the subject, AP Advisers Ltd is committed to the highest levels of ethical corporate governance, and its staff regularly contribute time and effort to the good of the local community whenever it is able.         

Robert Williams
Senior Investment Adviser