Stock market and economic commentary December 21

“Predicting rain doesn’t count, building an Ark does.”

Warren Buffett, American business magnate, investor, and philanthropist.

Economic Update

“Same procedure as last year? Same procedure as every year!” The classic sketch “Dinner for One” is a New Year’s tradition in Germany and much of Northern Europe. Miss Sophie’s 90th birthday party and her famous reply to James, her butler is funnier if you have had a couple of glasses of champagne. It is the most frequently repeated television program in Germany ever, yet it is still largely unknown in the United Kingdom and the United States.

Same procedure as last year strikes us as an apt perspective for 2021. It was the second year in succession dominated by the Covid-19 virus and its variants. For many, it was once more a year of great challenge and hardship. The restrictions required to prevent healthcare systems from becoming overwhelmed have had a dramatic impact on schools, businesses and governments that will take years to overcome.

In 2020 it was the Delta variant, in 2021 it was Omicron. It does appear, however, that Omicron follows the trajectory of viruses that mutate and become more contagious but are less severe in impact. The experience of South Africa where the Omicron mutation first emerged is encouraging and we must hope that this year will see a more complete overcoming of the pandemic through vaccination, immunity, and treatment.

2021 was also the second year of resilience against adversity, with global economic recovery, strong underlying demand for almost all imaginable goods and services, corporate profitability, increasing employment and rising incomes.

As a result of the elevated levels of government debt, policymakers are robustly pursuing monetary and fiscal stimulus to generate a strong economic recovery to help pay down the debt. And while accepting that the economic background has become more challenging in recent months, the global economy ended 2021 in decent shape and is currently entering a period of strong economic recovery. Manufacturers are enjoying strong orders albeit with difficulties fulfilling them, due to supply constraints but it is likely that once disruptions from the pandemic subside, there will be a massive supply response to the acute shortages in labour, industrial production and the provision of other goods and services.

Although it is possible that the current spike in inflation will moderate, it is quite likely that global economic growth, higher employment and better wages will mean that we could go back to a period of sustained inflation. Investors should, therefore, think about the types of assets that can preserve and increase their value in an inflationary world.

At the moment both cash and bonds offer an interest rate far below that of inflation. Bonds have the added problem of leaving the owner at the mercy of the market when they come to sell and in a rising interest rate environment, they may get back less than if they held the bond to maturity. Property is also an area of interest however, the costs of upkeep rise significantly with inflation, as anyone who has attempted home renovations in the last 18 months will attest to.

By far the most important and promising opportunities for investors are productive assets, companies with superior pricing power that can grow their sales and earnings over the long term. Bonds will struggle with rising interest rates and equities are the most important liquid asset class that can generate value in an inflationary environment.

The companies to buy are those that have sustainable competitive advantages in good and growing industries, the ability to grow and to innovate through investment in research & development and acquisitions, the pricing power to pass on price increases, and the scale and resources to absorb increases in costs of labour or raw materials.

Same procedure as last year? Same procedure as every year!

It is no coincidence that these are the key criteria for the companies in which our fund managers invest. Investing in companies that have quality and value for the long term and in the biggest and best of those companies, is the simplest and easiest way to inflation-proof portfolios and to generate value over the long term.

Stock Markets

All serious investors should pause at least once a year to admit their mistakes. As human beings, we normally learn more from our failures than our successes. So, though painful, this reflection should help us refine our approach and identify whether we need to change it.

We could be forgiven for thinking that last year was quite strange. Global equities rose more than 18% in sterling terms. This adds up to a gain of more than 70% over five years and almost 400% since the financial crisis market low in February 2009. Anyone would think we had enjoyed an unprecedented economic boom when in fact it is quite the opposite. Equity returns this high when economic growth has been muted is, some would say, weird!

It is by no means a fair comparison because it would be akin to comparing the Ark with the Titanic, but the medium risk Clarion Portfolio fund, Meridian, which was never intended to shoot the lights out as most clients prefer a ‘steady as she goes’ approach, with less volatility than global equities, achieved returns of 9% over 1 year, more than 35% over 5 years and almost 200% since the market low in February 2009. We prefer the safety of the Ark to the more volatile high rollers and big dippers experienced by the Titanic. It is also fair to mention that despite having a lower exposure to stocks & shares the Meridian fund has outperformed the UK leading index, the FTSE 100, over most time periods.

US CPI inflation rose from 1.2% in 2020 to 6.2% in 2021. US 10-year bond yields ended 2020 at 0.8% and at 1.4% end 2021. Conventional economic wisdom tells us that as inflation rises, bond yields should rise in tandem. So, in a period when inflation rose 5%, bond yields have only risen 0.6%. Weird!!

Some areas of the equity markets have behaved weirdly too. Our biggest failing this year has not been to invest with fund managers who bought weird, expensive stocks. Take Tesla which at one point was up more than 40% in 2021. The company is on course to generate just under $10billion in income in 2022 yet at more than $1trillion, it is valued at more than 100 times that income. That is a crazy valuation….and weird!!

Tesla is a perfectly sensible company in which to invest; just not at the current valuation which allows absolutely no margin for error. However, it cannot compare in the weird stakes with Rivian Automotive, whose IPO was recently backed by Amazon and Ford. It is currently valued at close to $100 billion – more than Ford and General Motors. It only began delivering its first trucks in October and currently, it has zero revenues. Weird!!

The rise of meme stocks in 2021 was a classic speculative bubble, but with one crucial difference. Most bubbles through history are fuelled by an excess of greed. This one was driven by rage — and desperation. The people piling into GameStop and other meme stocks wanted to force short sellers out of business. They saw them as responsible for the financial crisis of 2008/9, and for the steepening inequality and injustice that followed it. Many of them felt as though they had nothing to lose, and no alternative but to gamble everything on a few bets. Buyers were motivated by righteous anger, co-opting markets to right wrongs and improve society. Nothing like that has happened before, and it is a perilous situation and very… weird!!

Hunter S Thompson, the US journalist and author once said, “when the going turns weird, the weird turn pro”. Some investors who have backed such odd stocks have decided to offer their services as long term savings managers on the basis that they know the market better than experienced, professional fund managers. What could go wrong? Well, just about everything, so we at Clarion will continue to only invest client funds through professional fund managers with proven long term investment performance records.

Interest rates have been kept low on the assumption that current inflation trends are transitory. But central banks are in a difficult position. German retirees who invest mainly in bonds – which today yield close to nichts – will not tolerate minus 6% real returns much longer.

This could be the year when the global economy enters a new regime. No longer driven by minimal inflation in prices, negligible interest rates, steadily falling bond yields, growing inequality, and fantastic returns on asset prices, it’s possible that the return of rising prices in 2021 will at last force a new way of doing things. With inflation a serious practical problem for the first time in a generation, the assumptions that “there is no alternative” to stocks and shares, or that independent central banks can defend confidence in the currency, finally come into question.

But nothing is certain in the exceptional circumstances that follow the pandemic, and, in a sense, nothing is new. US Federal Reserve policy is what really matters. Same procedure as last year? Same procedure as every year?

Whatever 2022 can throw at us—new Covid variants, geopolitics, global warming – the number one point of discussion among investors is the same as it has been for most of the past year; inflation. If policymakers respond to what has been a surprising burst higher in price pressures and the Fed seeks to douse them down aggressively with rapid rises in interest rates, then some risky assets will be vulnerable. And some safe assets such as governments bonds may be even more vulnerable.

We will be monitoring the situation closely.

There is increasing economic, social, and personal welfare uncertainty due to the emergence of the Omicron variant of the Covid-19 virus. However, society is better prepared to respond to this threat compared to earlier variants. A sizeable proportion of the population in the developed world has been vaccinated or has developed some natural immunity to Covid-19. Technology has now been developed to create new, targeted vaccines quite quickly. And governments have a greater understanding of how to roll out social policies which slow transmission, whilst minimising the impact on the economy. Whilst we should always be alert to potential new risks, there are reasons to remain cautiously optimistic that the economy will remain on a strong recovery path from the pandemic.

2022 is going to be tricky for British consumers who are facing a triple whammy of soaring energy bills, a 1.25pc point rise in national insurance contributions and higher borrowing costs. But before buying into this despair, it is worth reflecting on what is going well. The IMF, OECD, and economists at Goldman Sachs project that the UK will be among the fastest-growing advanced economies in 2022. Homeowners will be comforted by the fact that house prices grew in 2021 by more than 10%, the biggest increase since 2006. Stock markets have clawed back all their Covid losses and are now showing healthy returns. Many households sit on a savings cushion valued at more than £200 billion.

We have faced many challenges and will undoubtedly face many more, but we look forward to a brighter 2022 with confidence. We wish all our clients and their friends and families a happy, healthy, and prosperous 2022.

Keith W Thompson

Clarion Group Chairman

January 2022

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

Risk Warnings

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.

Stock market and economic commentary – December 2021

Stock market and economic commentary – December 2021

Economic Update

Stock Markets

Risk Warnings