Market commentary: 1 April 2022 to 30 June 2022

We noted at the end of Q1 2022 that markets and asset prices were displaying a tranquillity that was hard to reconcile with the deteriorating economic backdrop. Q2 saw that tranquillity dissolve as US stock markets tumbled and bond yields climbed. This is a perfect reversal from the ‘everything rally’ of 2021, where all asset classes had a positive year, to an ‘everything falls’ environment.

To recap, 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 six months and, while opportunities will present themselves in the future, we remain tightly focused on preserving capital where we can.

That is not to say we can eliminate all potential losses; some things are within our control and some are not. We do not control stock markets and asset prices and all portfolios will show some red ink so far in 2022 as pretty much every asset class has fallen in value. We have been successful in limiting these losses, which is pleasing, but it poses an existential question we are sometimes asked by clients: “if you view the future with pessimism then why not just sell everything?” and we should discuss this further.

We are high conviction investors as a general rule. That is, we are prepared to take a view on markets and asset prices that does not accord with prevailing wisdom, and we are willing to assert that view to a larger degree in our clients’ portfolios than most other investment managers. We do this because unless you are willing to invest differently than the market then you can have no hope of outperforming it. Over the last ten years we have only used this capacity to the full to reduce risk during the times our analysis suggests that taking on risk will lead to unsatisfactory returns.

At times it is tempting to want to sell everything, but there are reasons why we do not. One issue, for most clients, is that there may be a capital gains tax consequence should we liquidate your portfolio. If we chose to crystallise all of the capital gains it is in effect volunteering to reduce the portfolio value through excess taxation – even if markets were to go nowhere.

If, as investment managers, we felt we had sufficient certainty over the future downwards trajectory for markets then this elective tax drag might be worthwhile, but there is little certainty to be had.

The major reason for not selling everything when you fear losses may be coming is more prosaic: we could be wrong. The way we invest is by tweaking the dial between taking more risk and taking less risk, and between asset classes, as our views over economies and asset prices evolve. What we do not do is make binary, black or white, red or black, all-in or all-out bets.

As things stand at the end of the first half of 2022, we have a high conviction over the following: that inflation will persist, interest rates will rise, recession is coming and that high asset values cannot withstand these forces.

However, as we have been saying for some years, the economic signals we are receiving have never been harder to read. The response to the global economy, still recovering from lockdowns, supply shortages and even the firehosing of cash from the financial crisis, from rising inflation and interest rates is opaque and hard to gauge.

As things stand, we are experiencing falling asset values, but should investors start taking the view that the economic backdrop is sufficiently bad that interest rates will not continue to rise (for fear of causing a deeper recession) then this provides a support for bond yields and asset prices which could see stock markets rise. This is why, perversely, a worsening outlook for economies could see stock markets rising and why we must temper our convictions and invest with a probabilistic approach rather than a binary one.

What could determine the second half of 2022 for investors is the persistence of inflation and the willingness of central banks to reign it in with higher interest rates when this will inexorably lead to recession. 2021 demonstrated that central banks do not react with sufficient speed or decisiveness to quell inflation. As such our investment strategy remains firmly focused, as it has been throughout 2022, on living and investing in a high inflation world.

We remain highly defensively positioned and, unless circumstances change radically, this is likely to stay the case for the next quarter.