Market Musings 08/01/22:
Changing Leadership?

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Investment Strategy Focus, January 2022

Summary:

Surging inflation is pressuring households, forcing central banks to raise rates
Wage growth is key to longer-term inflation trends - and it is rising
But the labour market is still missing a lot of workers, particularly part-time and older
The global economy is today more sensitive to long-term interest rates than central bank base rates
Long-term interest rates (bond yields) are rising, putting pressure on growth stocks
Average S&P 500 stock has already outperformed the average Nasdaq stock since mid-2020
Under the surface of the tech sector, many retail favourite stocks have suffered, e.g. the ARK Innovation ETF (-40% since its February 2021 peak)
Rotation into more cyclical sectors that can benefit from higher inflation/rates is taking place - favours Financials (Banks, Life Insurance), Mining and Oil.
Dividend/dividend growth strategies with a bias to these sectors are doing well - e.g. the IUKD iShares UK Dividend ETF.
The Retail sector should continue to perform well off the back of the boost to households from housing wealth, falling unemployment and higher wages.

Inflation obsession

Financial markets are currently preoccupied with the question of inflation. Official inflation rates are very high by historic standards at the moment, far higher than what we've experienced since 2009 (i.e. the Great Financial Crisis), with inflation rates ranging somewhere between 2.5% and as high as 5% in developed economies. We have to consider the risk that this represents to the economy and to our wealth invested in financial markets today.

Core inflation has surged in 2021

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Source: BNP Paribas, Bloomberg

Separating out the transitory effects perhaps linked to lockdowns and the current supply chain difficulties from longer-term inflationary pressures, perhaps related to salaries and also energy prices as we transition to a low carbon economy, is tricky at the moment.

I see the key variable as the employment market. For example, in the US we can see that salaries are rising by something approaching 5% per year at the moment which is far higher than the 2% that we've been used to over the last few years. Similar is true in the UK, although in the case of the UK, this is to some extent linked to the disruptions around…

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Zipmanpeter

10th Jan '22

Thx - so many insightful graphs collected together; the UK one on FT vs PT employment trends stood out for me.

The other dimension I think you could have called out is age. The "old" have benefitted relatively vs the "young" from wealth and consistent income over the last few (esp COVID years) via house prices, guaranteed pensions and being the group most firmly locked down so not spending. However, they have finally discovered online shopping - participation by the "young-old" ie aged 55-70 has boomed which together with working from home, has structurally changed retail.

I therefore think your hope for consumption-led recovery will remain modest for most traditional retailers but should be very strong retailers with modernised offers, especially those with slightly older, consumer bases. (My favourites at the moment therefore include Saga and, inspired by SCVR, ELTA). As ever time will tell.

Branoc

Thanks Edmund. I had no idea that mortgage rates were fixed for so long in the Eurozone. Those rates look ruinous for banks if rates do rise in any meaningful way but I presume they have some way to hedge for that?

Snowbum

12th Jan '22

Great article as always, many thanks Edmund.

Edmund Shing

Yes Branoc

a few things. Firstly French banks are very conservative in their lending policies, more so than in the UK, so have a near-zero default rate on mortgages. Secondly, they can finance these fixed rate mortgages through long-term interest rate swaps, thus hedging any interest rate risk. Of course, remember also that they have access to ultra-low (even negative) funding from the ECB, so that helps too.

Edmund

The Phoenix

13th Jan '22

Great stuff as always Edmund whats your thoughts on healthcare and tech now ? other than big five Google, Microsoft etc in the US a lot of the other tech stocks have come off quite a bit would you see value at this point or best to avoid until we are through the new rate cycle and inflation starts to come down.

I remember you calling banks and miners as the place to be back third of last year so would value your current sector musings.

Regards

Andy

Wilbraham

I know Cathie Wood is occasionally prone to hyperbole but this short video by one of her acolytes suggests the China property bubble burst is going to make the Japanese bubble of 30 years ago look like a teddy bears' picnic. With significant knock-on to iron, copper, even DRAM etc prices. Hard to know whether to put our money on CW's narrative of those who still maintain we're in a commodities supercycle!

Market Musings 08/01/22: Changing Leadership?

Market Musings 08/01/22:
Changing Leadership?

Summary:

Inflation obsession

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Edmund Shing

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