As the New Year bells heralded the start of 2022, hopes had been high that the Covid era was finally coming to a close and some sense of normalcy would return to the world. Inflation was still being talked about as transitory, global supply chains were shaking off the cobwebs accumulated over two years of lockdowns and the outlook appeared reasonably benign.
Cue Russia invading Ukraine, ballooning inflation, increasingly aggressive central bank action in most western markets, a change of UK prime minister, a disastrous mini-budget that triggered a gilt market meltdown, another change of PM and an autumn statement.
Of course, the impact of those events – and the less seismic market shocks too numerous to name – is not uniformly felt by investors. Two, however, stand out – high inflation and the Russian invasion.
The former is, presently, predicted to start tapering off in 2023 before returning to some semblance of ‘normal’ by 2024; the full effects of the latter, however, are not expected to be truly felt until this year.
But after a year of shocks, twists and turns – how much confidence can fund managers and investors have in predictions, outlooks and forecasts?
As we approach the end of any given year, thoughts invariably turn to what lessons we have learned and how to avoid repeating them.
For Europe senior research analyst Nick Timpson, it is just that, to be sceptical of consensus opinion.
“The market continues to throw up surprises that seem to surprise everyone. That, of course, can’t be the case but I think it’s important to understand something like the Ukraine war, where there was general consensus that wasn’t going to happen. And then it did.”
Pointing to the Brexit vote and election of former US president Donald Trump, Timpson adds: “We’ve had several examples of significant events playing out in the past few years where the general wisdom was wrong. I think you have to take away from that an increased level of scepticism about what major media outlets and commentators are saying and think more carefully about what happens in each scenario, because some investors got really caught out by that this year.”
He says: “You can’t just rely on very shallow analysis of these major issues.”
Given his focus on concentrated global growth equities, Timpson has been mostly insulated from the goings on in Whitehall. What has taken up time, effort and energy, however, have been the drivers of steadily rising inflation.
“The Ukraine war, in isolation, is clearly an awful series of events, but the global impact has really been seen in the very high inflation and how that has driven the tightening monetary policy.”
As such, “the market direction and activity this year has been dominated by interest rate policy and rising rates”.
While the Ukraine conflict added fuel to the inflation conflagration, it is not the only geopolitical tension making waves. Timpson points to the souring relations between the US and China and the reshoring of industries, of which semiconductors is the “poster child”.
He adds: “We are not expecting inflation to fall right back to 1-2% because factors like deglobalisation and structural changes in energy supply, among others, will probably support prices for a few years to come.”
Gloomy picture with a silver lining
With an eye on all things global resource equities, Schroders portfolio manager Felix Odey has a similar view on the events of the past year and how it will see countries increasingly turning inward – especially when it comes to food supply.
In the immediate aftermath of the Russian invasion, he says markets suddenly had to absorb a lot of information. “Before the Ukraine crisis, there was a population of around 45 million people feeding about 600 million people around the world. When we talk about the breadbasket of Europe, that’s not a euphemism. That’s very true.”
He predicts there will not only be food supply concerns next year, but also “huge uncertainty for agricultural markets”.
“You’ve also had the knock-on impacts from the sanctions on Belarus and Russia, which account for about 40% of key fertilisers, such as potash. Europe is hugely reliant on Russia for things like ammonia and nitrogen-based fertilisers.”
Echoing the comments from Timpson around deglobalisation, Odey points to recent efforts by India and Indonesia to drive down spiralling domestic prices on wheat and palm oil through protectionist measures.
“Food is crucial, we rely on a very delicate system, and we know it can underpin huge political unrest,” he adds. While the picture looks distinctly gloomy, Odey says it is “very easy in this job to swing between being very pessimistic and optimistic”.
But the silver lining, he says, is the challenging market conditions will incentivise the adoption of greener and more sustainable technologies. “There are amazing developments out there coming through, and because they are all about efficiency it will be about producing more but with less CO2 emissions, waste and water usage.”
The one blot on the landscape, he concedes, is that these advances in food production and agtech will do little to bring down inflation.
The Ukraine crisis “drove the market to go from ‘inflation will be temporary’ to ‘inflation will be permanent’”. Add to that a tight labour market and higher wages and “the stickiness of that inflation starts to be cemented in”.
As for what Odey will take away from 2022, he says “this has been a really good year for showing the importance of discipline, but also recognising that the market can move very, very quickly”.
“It has been hard to time every single rotation, but what I’ve learned is, ultimately, fundamental valuation works. You’ve got to have patience and, especially when you’re a specialist, you have to be conscious of the macro because that can define a year and even multiple years.
“For me, it’s always that balance of making sure we are experts in our topic and areas that we cover, but also aware of what generalists are thinking and what the markets are thinking across asset classes as well. Bonds played a huge role in equity markets this year. So that is probably my biggest lesson – don’t become blind to what is going on outside of your immediate expertise.”
‘A painful Renaissance’
Axa Investment Managers’ senior fixed income portfolio manager Nicolas Trindade succinctly sums up 2022 as “a rollercoaster ride”. He and his team read the writing on the wall in late 2021 and concluded “inflation was going to be higher than what markets were pricing in, and valuations were really expensive”. So, they took steps early on to de-risk the portfolio.
“The level of re-pricing that we have seen this year has been incredible and like nothing we have seen in a generation.”
Fixed income struggled to generate much investor enthusiasm in the post-financial crisis era, but that has changed significantly this year, especially when it comes to short-dated strategies. “The yield on the fund I manage is 6%,” says Trindade, “which is the most attractive is has been since inception back in November 2010.”
An emphatic tailwind for his fund was undoubtedly the eyebrow-raising ‘fiscal event’, which ultimately led to the downfalls of chancellor of the Exchequer Kwasi Kwarteng and prime minister Liz Truss. A lot of money flowed into Trindade’s fund in the wake of this mini-budget.
That the plans outlined by Kwarteng and Truss were going to be fairly aggressive, in terms of unfunded tax cuts, was pretty much accepted by the market. “We didn’t think they would go as far as they did,” he admits. “I think HM Treasury and the prime minister really underestimated the impact it could have and misjudged the nervousness in the market.”
Amid the subsequent mass sell-off in gilts, intervention by the Bank of England and growing concerns around financial stability, especially for pension funds, Trindade recalls “sitting at my desk and looking at yields increasing dramatically, thinking ‘where is the ceiling?’”.
“It was quite a stressful period,” he says. It succeeded, however, in triggering something of a “painful Renaissance” in fixed income, as Trindade puts it, although he would have much preferred “it happened in a less painful way”.
As for the experiences Trindade will carry with him, the first dates back to March 2020. “Basically, we had a ‘risk-free’ bucket of assets; namely highly rated banks and single- and double-A rated corporates that were very defensive in nature and had very strong balance sheets that we felt we could sell even in very difficult market conditions.
“But liquidity dried up and, even for very strong corporates and banks, our ability to trade was very limited or not at the price we wanted.”
As a result, when the portfolio was de-risked in 2021, instead of investing in a lot of double-A rated banks or strong single-A corporates, Trindade and his team bought very short-dated government-guaranteed debt to make sure “we had a proper risk-free bucket within the portfolio”.
His lesson from 2022, however, was that there is always a limit to economic forecasts. “I think 2022 has illustrated that point very, very well. What that means is you have to be very well diversified within your strategy. In terms of active management, timing the market is very difficult, so we like to do it on a gradual basis when we think the valuations are attractive.
“But I think it is important to always keep an open mind to the contrarian view and always have in the back of your mind the question ‘what if the economist is wrong?’”
Market consciousness
David Cumming only joined Newton Investment Management in March 2022. What some might consider a baptism of fire has barely fazed the UK equities veteran, who started his career in 1983. He even goes so far as to say he has “enjoyed this year”.
A big part of that, undoubtedly, is a result of the performance his fund managed to deliver after political and macro events “created a lot of movement at the stock level and opened up opportunities”.
“We’ve had more wins than losses and perhaps a bit of luck as well, if we’re honest,” he wryly notes. “The market has changed significantly, and we’ve fortunately been able to adapt.
“There has been a lot packed into this year,” he says. “You don’t often get this level of inflation and this much geopolitical risk at the same time. But the global financial crisis was worse because you had the banking system on the verge of going bust, so the financial threat was real.
“The political threats around war are difficult to price in. What we see on the financial side, assuming the conflict in Ukraine doesn’t escalate, is not as significant as in 2007/08.”
Cumming is a believer that when you get market dislocation, fund managers can take advantage of opportunities provided they “retain emotional control and observe a framework, in terms of how you operate, in terms of valuation etc”.
“The market is rational,” he says. “Reality tends to come through, although there are certainly long and variable lags to that.”
He points to the mini-budget, which Cumming describes as “not based in reality”, which had people “buying into some sort of paradigm shift and that was just not real”.
“There are realities around financial markets, around paying your way, around debt, inflation etc that have an impact. Those have come back into the market consciousness.”
A common thread that ran through each of my interviews was about the opportunities these sometimes alarming and unpredictable events can throw up. Nobody could have predicted half of the events that unfolded during 2022.
I think we can all generally agree, however, that a rational strategy is to heed the consensus opinion while maintaining a weather eye on the horizon, stick true to tried and tested frameworks and methodologies, and practise being patient.
Most parables have disputed origins and details, but my favourite version of this story is as follows.
A Persian ruler summoned his councillors and tasked them with coming up with a phrase that would be true in all circumstances. After much deliberation, they presented him with the words: “This too shall pass.”
As 2022 hurtles towards its final destination, that phrase undoubtedly rings true. As for 2023 … well, another saying that springs to mind would be ‘que sera, sera’.
This article first appeared in the December edition of Portfolio Adviser Magazine
