Square Mile Update

We wanted to write to you about yesterday’s wobble in the stock markets that suddenly got the gitters amid worries that US inflation is set to rise.

In the US, the Dow Jones Index dropped 470 points, or 1.4% in value, to record its worst trading day since late February. It looks as if this sell off will be followed by further weakness today with what are called US stock market futures declining in early trading this morning about 240 points. The market was dragged down further by losses from big names such as Home Depot, Chevron and Goldman Sachs.

The UK and other European bourses also saw steep declines on fears among traders that rising consumer prices could push up interest rates.

The UK's benchmark share index, the FTSE 100, closed down 175 points, or approximately 2.4% lower. The UK market had only just hit a post-pandemic high of 7,164 on Monday.

According to market commentators the market continues to be nervous of inflation which is clouding the apparent recovery from Covid 19. Surging commodity prices in recent days are a sign of this, and one of the key drivers behind these concerns are the huge infrastructure and stimulus packages in the US.

In March, US President Joe Biden signed a bill for £1.4trn of spending that saw the government send $1,400 cheques to most Americans, and last month he set out plans for more government spending on education, social care and jobs. This handout has added to savings and is now being spent by many as the economy reopens, thus driving prices higher.

In the US, inflation figures have now hit 2.6% in the 12-month period to March this year, which breaches the Federal Reserve's target of 2% and thereby raising fears it might raise rates to cool things down. However, Jerome Powell who is the Fed chairman, has stressed repeatedly that he is not thinking of raising interest rates as he believes the rise in inflation is only temporary.

There are similar concerns in other economies, but central banks have so far played down the risks. What we have to remember is that inflation was always likely to pick-up over the next few months given that in the same period a year ago economies were closed and oil prices slumped, and so the figures are from a very low base.

If inflation persists and we are still talking about this in the months to come, then that is a different scenario and will potentially lead to higher interest rates. However, runaway inflation does not look likely and projected growth and inflation rates for many economies look much more subdued in 2022 and beyond.

In the case of some stocks, other news coincided with the market fears on inflation, including British Airways owner IAG shares falling more than 7% on the back of negative investor reaction to the government's green list of safe countries to travel to. Shares in NatWest Group fell more than 3% following the government announcement on Tuesday morning that it had sold another chunk of shares in the bank, reducing its stake to 54.8% and raising £1.1bn for taxpayers.

The concerns in markets are not only about the United States, but that is the main focus of the nervousness. In common with many other governments, the US has supported household incomes at a time when people have been unable or unwilling to spend as they normally would. It does not look as if the central banks will change their current stance and raise interest rates any time soon, but the markets and investors are likely to remain wary that inflationary pressures might prove to be persistent and lead the Fed to rethink.

There are two very diverse views in the markets at the moment which are causing a lot of volatility or turbulence as investors try and decide which will win out – strong growth and inflation or weakening economies and unemployment post the ending of various government support schemes, including the furlough scheme here in the UK. As such, expect markets to swing violently around until we get more clarity on what outcome will prevail.

So, we thought it important to summarise where we stand in terms of portfolio positioning and our thoughts at the current time. Firstly, if history is anything to go by then equities usually do reasonably well through periods of inflation below 5%, despite the wobbles seen across markets yesterday. A little bit of growth is broadly good for company profits and it is only when you get runaway inflation that problems really start to occur.

As for bonds, it is not great news as higher inflation may mean higher interest rates which usually means a backup in bond prices.

At present, we are not overweight equities due to current market uncertainty and so we are broadly cautious in how we are positioned. Furthermore, we have already baked in some inflation protection into our portfolios with many of our investors holding the Twenty Four Monument Bond fund in their fixed interest mix. This fund which should do well as it holds variable rate bond holdings which are designed to offer higher interest in periods of higher interest rates and inflation. Within equities we also widely hold the Legg Mason IF ClearBridge Global Infrastructure Income fund, a strategy where many of the underlying holdings have inflation linked cash flows.

Secondly, in some portfolios we still have cash reserves and will look to start to re-invest this should equities, in particular, begin to take a more significant hit. Should we see equity markets down by more than 10%, we will likely go overweight equities in most portfolios for buying cheap(er) assets has usually served investors well. We are also looking at adding back to the UK Gilt market should the yield on the 10-year bonds approach 1% where they offer much greater value in today’s miserly markets.

We are always happy to chat should you need further information, or should your clients need reassuring as we understand how unsettling these headlines can be.

We look forward to seeing you all in person in the not too distant future.

Mark, Charles, Andrew and Chris

Our thoughts expressed in this update relate only to the portfolios we manage, or advise on, on behalf of our clients and as such may not be relevant to portfolios managed by other parties.

This update is only aimed at professional advisers and regulated firms and should not be passed on to or relied upon by any other persons. It is not intended for retail investors, who should obtain professional or specialist advice before taking, or refraining from, any action on the basis of this briefing, remembering past performance is not an indication of future performance. Square Mile Investment Services Limited makes no warranties or representations regarding the accuracy or completeness of the information contained herein. Square Mile does not offer investment advice or make recommendations regarding investments and nothing in this update shall be deemed to constitute financial or investment advice in any way. This update shall not constitute or be deemed to constitute an invitation or inducement to any person to engage in investment activity and is not a recommendation to buy or sell any funds or investments that are mentioned during this update.