Stock market and economic commentary August 2022

“The whole aim of practical politics is to keep the populace alarmed, and hence clamorous to be led to safety, by menacing it with an endless series of hobgoblins, all of them imaginary.”

Henry Louis Mencken (1880-1956), American journalist, essayist, satirist, cultural critic, and scholar of American English. He commented widely on the social scene, literature, music, prominent politicians, and contemporary movements.

Ukraine

European gas prices surged, increasing the risk of a European recession after Russia further reduced shipments of gas through the Russia-Germany Nord Stream 1 pipeline. The EU agreed emergency measures to reduce gas demand, albeit slightly watered down from original proposals. Russia warned it would suspend US inspections of its nuclear arsenal as retaliation to Western sanctions following its invasion of Ukraine.

US lawmakers agreed to send the largest single military aid package to Ukraine since the start of the war amounting to $1bn. Creditors have agreed to Ukraine’s request for a two-year freeze on its $20bn of foreign debt payments. The first grain shipment out of Ukraine, since the Black Sea blockade started, found a new buyer, and eased fears of a global food crisis.

Hungarian biggest refiner MOL has paid Russia’s transit fee to resolve a dispute that halted oil flows to Europe. Spain and Portugal supported German chancellor Olaf Scholz’s suggestion for developing a European gas pipeline to help diversify the continent’s energy supply

The United Nations High Commissioner for Refugees estimated that 12m people have fled the Ukraine conflict, of whom 7m have been displaced inside the country.

The EU transferred the first two €500m tranches of a total €9bn of financial aid to help Ukraine’s finances in the war effort. The US Treasury imposed sanctions on several Kremlin-connected elites including Alina Kabaeva, a member of Russia’s parliament and Vladimir Putin’s reputed partner.

A Ukrainian offensive to recapture the strategically important city of Kherson is gathering pace, according to military sources quoted by the BBC.

Russian foreign minister Sergei Lavrov confirmed that Russia’s war goals now extend to territory in the south of Ukraine, in addition to territory in the east of Ukraine.

Richard Moore, head of the UK intelligence service MI6, said that Russia was about to “run out of steam” in Ukraine as it struggled with logistics. Over 75,000 Russian troops have been killed or wounded in Ukraine, according to US estimates, CNN reports.

Economic Update

One of Britain’s most memorable characters is Eeyore, the perpetually melancholy donkey from A.A. Milne’s stories of Winnie the Pooh. Sitting on his own at his house on Pooh Corner, his attitude condemned him to a lifetime of misery. Perhaps the Bank of England’s Governor, Andrew Bailey, missed an opportunity when he didn’t channel his inner Eeyore pessimism to greet journalists at the press conference on 4^th August with a cheery: “Good morning, if it is a good morning. Which I very much doubt”.

It’s hard not to think of Eeyore when reading the commentary published by the Bank following that meeting which announced that it would be raising interest rates by 50 basis points, the biggest increase since 1995 (and the biggest ever since the BoE gained its independence under Tony Blair and Gordon Brown in 1997).

In resolving the hottest debate in economics, the Bank warned that the UK would fall into a recession later this year. As central bank announcements go, this was a bombshell. Never has the Bank produced a growth forecast that is so much weaker than market consensus. Until this depressing prediction, all but two of the 27 forecasters surveyed by the publication ‘Consensus Economics’ were forecasting that the UK economy would expand next year. With its forecast of a 1.5% contraction in GDP in 2023, and a five-quarter recession, the Bank has rewritten the future, warning that we are heading for a downturn on the scale of the 1990-92 recession.

But the last few months provide ample illustration of the fallibility of economic forecasts. What looked like a solid recovery six months ago now appears to be turning into an inflation-driven recession. Yet the Bank’s latest forecasts are only a point in time view – it’s not hard to think of things that could change them. It is also worth remembering that shortly after the Brexit referendum vote in 2016, the Bank warned that the UK would suffer a deep and prolonged recession. That didn’t materialise. And of course, as early as last November Mr Bailey was still insisting that inflation would be transitory.

In the 1970s and 1980s high rates of inflation threatened economies and social stability across the West. Since then, independent central banks have helped tame inflation, aided by rapid globalisation that has provided Western consumers with more and cheaper goods. For most of the last 25 years, inflation rates have bobbed around the 2.0% mark. Politicians and voters haven’t needed to worry about inflation but with the recent surge in prices, inflation has moved to centre stage again.

There are many similarities between this year and 1977 – a Royal Jubilee, strikes, painful inflation and second place in the Eurovision Song Contest. Back then we entertained European audiences with a chirpy little ditty by Lynsey de Paul entitled “Rock Bottom”. If all the negative publicity is to be believed, this just about sums up the UK today. We are predicted to have the lowest growth rate next year of any G20 country, apart from Russia. In a repeat of 1977 when they took top spot in the Eurovision Song Contest, even France is expected to beat us in the growth stakes.

My own musical tastes were a little more conventional in those days with stars such as Paul McCartney, Fleetwood Mac, Rod Stewart and Abba heading the charts. And, in confirmation that class is permanent but form and fashion, musical or economical, are temporary, many of the 1977 stars are still here today. Quality endures. This most certainly applies to a lot of the companies in which our carefully chosen star fund managers invest.

This was also the era of what became known as “stop go” economics, when governments flipped between stimulus and constraint, alternatively creating boom and bust. The concern is that today’s financial rock stars, our central bankers, will follow the 1970s playbook and to tame inflation they will adopt a masochistic approach to monetarism and raise interest rates too far, too fast.

To hear the recent cacophony of despair you would think the UK was in terminal decline. The doomsday narrative peddled by the usual British critics – to say nothing of our foreign detractors – is not only disappointing to hear, but it risks becoming self-fulfilling, damaging confidence and the willingness of domestic and international firms to invest in the country. As observed recently by Lloyds Bank boss Charlie Nunn, with all the negativism of the public debate, the country is in danger of talking itself into recession.

Yet the reality is far more complicated and, in places, uplifting.

There is much to be proud of. The aerospace industry is thriving with BAE Systems reporting a record order book of more than £52 billion. Witness new initiatives in life sciences, a new world-beating Covid vaccine, huge investment in high tech, record trade surpluses for the City and unquenchable demand for UK creative talent. Together they are combining to make Britain a compelling place to do business.

The Government’s ‘levelling up’ agenda, at which critics so often sneer, is finally yielding results. In Darlington, the Chancellor of the Exchequer can sometimes be found working at HM Treasury’s new outpost.

On Teesside, the development of a flagship 4,500-acre freeport, with light touch regulation, is breathing life into communities and infrastructure ravaged by the decline of traditional industries. And though the RMT union is seeking to disrupt modernisation across the rail network, Darlington’s railway station is being upgraded. Town centres at Stockton and Middlesborough are also being upgraded.

In the first quarter of 2022, venture capital investment in UK start-ups reached more than £9 billion, a record, according to the UK’s Digital Economic Council. That placed Britain second only to the United States and ahead of China and India. Despite surging inflation and rising interest rates, more than 1000 UK start-ups have raised capital with particular focus on artificial intelligence and financial technology.

A vote of confidence in the future is also provided by a recent Deloitte survey of Chief Financial Officers which provides a snapshot of the thinking and strategies of UK CFOs. The CFOs interviewed in the survey are not giving up hope. Although they expect the business environment to get tougher, with growth turning negative, inflation above target levels and interest rates doubling, CFOs are not yet battening down the hatches. Risk appetite is only slightly below average levels, and well above the lows seen in the financial crisis, at the time of the EU referendum and during the pandemic.

CFOs are positive about medium-term prospects for investment. Most expect business productivity, spending on skills and investment in digital technology and assets to speed up in the next three years. For all the risks, CFOs have not given up on growth. And neither should Investors. Despite the doom and gloom from certain quarters, there is much to celebrate and much to look forward to.

And to add icing to the good news cake, our brilliant footballing Lionesses brought home the European Cup.

Stock Markets

Markets are facing challenging times, although there has been a tentative recovery since the end of June, fuelled by expectations that slowing economic growth may prompt the Federal Reserve to scale back its interest rate hiking cycle and a falling oil price, stock markets have seen their worst first 6 months since 1970. US equities were down by over 20 per cent, while the tech-heavy Nasdaq fell by almost 30%, its largest first-half decline ever. Parts of Europe and Asia have also seen steep falls. Bonds, which traditionally perform well, or at least better, when equity markets fall, have delivered negative returns in line with equities.

High inflation, rising interest rates, excessive debt, increased taxation, inadequate policy responses, a war in Ukraine and structural legacies, courtesy of the pandemic and geopolitical tensions, including the need to shorten business supply lines, are some of the variables. Volatility persists and investors’ nerves are being tested.

While the current macroeconomic and geopolitical environments remain challenging, investors should retain a balanced view. Those claiming the end of globalisation need to acknowledge world trade as a percentage of global GDP remains close to all-time highs. The Ukraine/Russia grain deal may assist with the food crisis. Western resolve in response to the Russian invasion of Ukraine bodes well generally. And while many political systems and global organisations could be serving their people better, individual endeavour and progress is ongoing.

For the first half of this year equity investors were mainly worried about high levels of inflation and rising interest rates, but we are now moving to worries about recession and how deep and how long this might be.

I am reminded of what farmers in the Lake District used to say when discussing the outlook for the weather. “If you can’t see the Langdales it’s raining, and if you can see the Langdales, it’s going to rain”. In a similar way, when asked whether we are heading towards a recession my usual answer is that whenever we are not in recession, we are heading towards one.

The only question is “when” and “how bad” and does the fact that there could be recession ahead mean we should reduce our investments or alter our portfolio allocation. In most cases, the answer will be “definitely not”.

Since 1920, there have been 17 recessions as well as one Great Depression, a world war and several smaller wars, multiple periods of worry about global cataclysm and now a pandemic and another war in Europe. And yet, the S&P 500 has returned about 10.5 per cent a year on average over that century plus.

Would investors have improved their performance by getting in and out of the market to avoid those problem spots or would doing so have diminished it? Importantly, even if we think we know what’s in store in terms of things like inflation, recessions and interest rates, there is no way to know whether market prices have correctly incorporated those expectations or whether prices are too high or too low.

Most investors have their eye on the wrong ball. One of the biggest changes I have witnessed in my career is the incredible shortening of investors’ time horizons hence the bouts of extreme, nerve-jangling, stock market volatility which occur from time to time.

One quarter or one year’s performance is meaningless at best and a harmful distraction at worst. No strategy, and no level of brilliance, will make every quarter or every year a successful one. Strategies become more or less effective as the environment changes and their popularity waxes and wanes. Often poor performance will be due to unforeseen and unforeseeable developments.

So, no one should change strategies based on short-term results. If you wait at a bus stop long enough, you are guaranteed to catch a bus. But if you run from one stop to the next, you may never catch a bus. Thus, we at Clarion will not be influenced by the short-term cycles of the investment crowd as we prefer to focus on the things that really matter.

The macroeconomic environment can influence short-term investment sentiment and style (for example, the switch from growth to value stocks and then back to growth again) but we should not forget that equities remain a key living embodiment of the human desire to progress across a broad range of sectors and disciplines. We must not lose sight of the worth of companies.

We believe that even if we do have a recession, quality companies with high gross margins that offer resilience, pricing power and long-term growth prospects will endure and will always offer the best chance of generating value over time.

As always, we thank you for your continued support and we look forward to updating you regularly throughout 2022. We invite you to get in touch if you have any questions.

Keith W Thompson

Clarion Group Chairman

August 2022

Creating better lives now and in the future for our clients, their families and those who are important to them.

Risk Warnings

The content of this article does not constitute financial advice and you may wish to seek professional advice based on your individual circumstances before making any financial decisions.

Any investment performance figures referred to relate to past performance which is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments, and the income arising from them, can go down as well as up and is not guaranteed, which means that you may not get back what you invested. Unless indicated otherwise, performance figures are stated in British Pounds. Where performance figures are stated in other currencies, changes in exchange rates may also cause an investment to fluctuate in value.