Market commentary: 1 January 2022 to 31 March 2022

As we end the first quarter of 2022 the performance of the FTSE100 (+2%) over the period would suggest a modest and tranquil progression. The disconnect between equity performance and the real world has been stark.

It is pleasing to see that UK equities have been (at long last) leading the pack (US equity -5%, Euro equity -10%), though we can’t claim too much credit for this. The surge in oil and commodity prices has led to the outperformance of those sectors and the FTSE100 has a disproportionately large component of those. Our preference for UK equity in general, though not the oil and commodities sectors, is based on their good value compared to their international peers; but we won’t grumble.

In our “Ukraine update” (March 2022) we reinforced the conclusions that we have been developing since the start of 2021. That the backdrop and context we face today is most reminiscent of the 70’s and that this is a sharp rebound from the forty years that followed. The problems we see emerging today are:

⦁ sustained high inflation
⦁ higher asset price volatility
⦁ wage increases
⦁ increased union activity / strikes
⦁ higher inventories and working capital
⦁ shorter, more local, supply chains
⦁ lower return on capital employed (ROCE), profits and margins
⦁ higher energy costs

What has changed over the last quarter?

1) Putin’s bloody folly in Ukraine has amplified and accelerated this process. It has also added increased militarisation into the equation – yet another factor that leads to higher government debt, higher inflation and lower economic growth.

There is uncertainty over the supply of oil, gas, industrial commodities, food, and fertiliser; prices have reacted as one would expect. Energy costs have risen by a higher % of GDP than at any time in the last 20 years. The steep rise in energy bills in the UK today is one of the unwelcome April fools jokes the world will play on personal finances.

2) Global supply chains and access to financial systems and services have been weaponised. Over the last two years the Western world has paused in its decades long integration of those countries with whom, let us say, we have ideological differences. China, Russia (+ satellite states), and the Gulf states have been the recipients of a sort of “nose-holding” appeasement in the past; an approach that could be characterised as “we don’t like the politics or the policy but if we become closer then they will gradually bend our way”. This approach has been perceptibly reversed and it appears that there is a growing recognition that the differences in values are neither malleable nor tolerable. Putin’s gambit has accelerated this trend towards deglobalisation.

3) Angela Merkel’s sixteen year legacy as German Chancellor has been utterly trashed in six weeks. The naive folly of her policies of closing down Germany’s nuclear power industry, huge investment in renewables, increasing reliance on Russian gas and oil, and decades of insufficient military spending has been crushingly revealed. Her policies may have burnished her reputation to Davos-man but Germany’s political appeasement of Russia, its vulnerability and its weakness has clearly contributed to both Putin’s coffers and Imperial ambitions. Every element of Merkel’s legacy has been reversed at speed.

Investment positioning

We started 2022 with a highly defensive position: high levels of cash, low credit risk and duration, significant gold reserves and a focus on cheaper equity markets. We have been extending these defensive positions over the last two months and did so again as the situation in Ukraine worsened.

The movement in sovereign debt yields is never the most thrilling of dinner party conversation topics. But the whole edifice (artifice?) of high asset valuations has been based on the scaffolding of central bank liquidity driving down sovereign debt yields. Over the last 6 weeks the yield on short term sovereign debt has risen sharply: 2 year US sovereign debt yields have risen from 0.75% to 2.4% since the start of the year; yet another reinforcement of our contention that the world is underestimating the risk of a recession in the US and Europe this year.

Our original rationale for the defensive position was not based on any foresight of this conflict emerging, but more on a simple understanding that when equity markets look stretched and macro-economic risks are mounting then the reward for taking risks is likely to be low. Our analysis suggested that a period of “battening down the hatches” would be prudent.

When markets and assets tumble it is usually impossible to fully insulate portfolios against all losses.

Our goal is to minimise losses where possible and be ready for the opportunities that emerge and we remain well positioned in this regard.