Let’s start with the big one - inflation
Inflation remains the big concern for investors right now, as shown by recent reactions to the latest US inflation number – it rose higher than expected in the 12 months to May, to 8.6%. US markets posted their biggest drop since January on the news.
For central banks, the challenge remains the need to bring prices under control, predominantly by raising interest rates, without tipping their economies into recession. For now, those interest rate rises keep on coming as their efforts to tackle inflation continue. Last week, the Bank of England raised rates from 1 per cent to 1.25 per cent, and the US Federal Reserve announced a rise of 0.75 per cent – its biggest hike since the mid-90s.
As for what will happen next with inflation, Coutts’ Head of Asset Allocation Lilian Chovin said the situation was different in the US and UK.
“While we anticipate US inflation to start peaking in Q3, the outlook for UK inflation is likely to be more stubborn,” he said. “With utility prices set to rise again in October, combined with relatively tight labour markets – compounded by Brexit limiting the number of people available for work – the long-term expectations for inflation in the UK are that it could stay higher for longer.”
The relatively good news is that markets have started readjusting to current conditions. They are factoring into asset prices persistently high inflation, a strong central bank response and potentially slower economic growth in the West.
Encouragingly, this means we’re starting to see increasingly attractive valuations across equities and bonds. And that could represent good buying opportunities.
China shows rays of hope
While there’s no doubting the difficulties investors are facing, it isn’t all doom and gloom.
A really good example of this comes from China. There’s growing evidence that, despite a strict zero Covid policy, the country’s economy could be turning a corner, having been quite slow in recent months.
One such sign is that we’re seeing an improving ‘Chinese Credit Impulse’ figure, which measures the change in public and private credit as a percentage of Chinese GDP. People and businesses are starting to borrow more, and that can give any economy a welcome boost. Historically, an improving credit impulse has been a good sign of better, future economic activity.
As the world’s second largest economy, China is very important to global growth, so a Chinese recovery could have a positive impact across markets. It’s already on a different trajectory to developed economies, its government focused on stimulating growth through direct financial support for its people and moves to stimulate broader economic expansion.
How we’re navigating current conditions for clients
At Coutts, we already knew that these challenging conditions were coming down the line and had positioned our client portfolios and funds accordingly. Here are just some highlights of how we’re navigating the current choppy waters:
- We had already reduced our exposure to inflation-sensitive growth stocks, such as technology, and mid-caps. Instead, we’ve focused on more resilient, large-cap stocks and defensive equities such as healthcare.
- With rate rises expected, fixed income has come under pressure, so we made sure we held fewer bonds than our benchmark. But more recently, the sector has started looking more attractive, so we bought more Investment Grade bonds where we’re seeing attractive yields.
- We see US inflation on a slightly different trajectory to UK inflation – potentially peaking sooner – and, with valuation levels not seen for years, we made a tactical decision to buy more US equities.
- With the outlook for the Chinese economy looking more positive, and the government focused on providing support, we increased our exposure to the country’s stocks via emerging markets and Chinese equity funds.
The value of investments can fall as well as rise and you may not get back what you put in. Past performance should not be seen as an indication of future performance.