7th July 2022
Welcome to the Whitechurch quarterly investment review. This review covers the key factors that have influenced investment markets over the past quarter and the Whitechurch Investment Team’s current views and broad strategies being employed.
The UK market delivered a return of -5.87%. In what was a mixed quarter, share prices were relatively stable throughout much of April and May, with almost all of the losses coming in the last few weeks of the period. As with last quarter, large cap stocks outperformed, returning -4.54%, while the more domestically oriented mid and small cap stocks returned -12.11% and -10.63% respectively. Several factors continued to weigh heavily on global markets throughout the period, namely the looming prospect of further interest rate rises and the impact of the ongoing invasion of Ukraine. The significant contrast to Q1 was the lacklustre performance of energy stocks in June, which had until that point been buoying the aggregate performance of UK blue chips. By sector, positive contribution came from healthcare (+5.86%), telecommunications (+3.08%), energy (+1.55%) and consumer staples (+1.23%). The laggards were basic materials (-18.43%), real estate (-16.28%), technology (-14.41%), consumer discretionary (-10.51%), industrials (-9.86%), utilities (-6.57%) and financials (-6.41%). The widespread sector losses resulted in a reversal of fortunes for the UK when compared to Q1, when the UK was the best performing major region.
Despite being a tough month for equities more widely, the early part of the quarter saw the UK continue to benefit from the recent preference among investors for so called ‘value’ stocks i.e., those in the more cyclical and lowly valued areas of the market perceived to be underappreciated. We highlighted last time some of the contributing factors towards what has turned out to be the most significant period of outperformance over their more growth-oriented counterparts in more than 20 years. The UK market continued to prove to be an attractive hunting ground for income investors, particularly given the scale of post-pandemic dividend restoration, with the large cap index averaging a yield of 3.9%. Despite relatively low valuations, a lack of technology names and positive exposure to sectors that benefit from a rising interest rate environment, such as financials and commodities, the region experienced heavy fund outflows.
Economic data early in the period was broadly encouraging, with the Office for National Statistics (ONS) publishing an unemployment rate of 3.8% in April – the lowest in almost 50 years. However, other figures released during the period showed UK inflation at a record 9.1% for May, as food prices increased at their fastest rate since 2009. Retail sales volume also recorded a modest decline from April to May. As the period progressed, the data became even more sobering, with confirmation from the ONS in June that, following overall growth in Q1, UK GDP declined by 0.1% during March and 0.3% in April. There were several contributors, with poor growth shown in services, manufacturing and construction – the first time that all main sectors contributed negatively to monthly GDP figures since January 2021. The macroeconomic backdrop and the slowdown in growth saw the OECD revise down their full-year estimates for the UK’s GDP recovery from 4.7% to 3.6% for 2022 and from 2.1% to 0.0% for 2023.
Unable to back up the strong performance shown in 2021, global equities experienced another difficult quarter. Headwinds such as multiple interest rate rises from central banks in an attempt to moderate the cost of living, the ongoing geopolitical and humanitarian crisis as a result of Russia’s invasion of Ukraine and supply chain disruption in the wake of the pandemic have all weighed heavily on markets this year to date. Whilst markets may have now arguably priced in factors such as the energy supply shock and relatively aggressive fiscal tightening from central banks, the upshot is that investors have become more cautious, as fears of a recession increase. In recognition of the reduced prospects for global recovery, the IMF confirmed in April that it had lowered its full year global GDP growth forecast from the 4.4% estimated in January to 3.6% for 2022 and from 3.8% to 3.6% for 2023. To put the recent run of poor performance of global equities into context, the year to date represents the worst H1 returns in more than 50 years.
The US was the worst performing major region over the quarter, as the main technology-laden indices continued to selloff, compounding the losses witnessed in Q1. We reported last time that, after months of speculation and pressure to intervene in the rising cost of living, the US Federal Reserve (Fed) increased interest rates for the first time in over three years in March. In hindsight, this merely set the tone for what was to come, with a further 1.25% of increases announced in Q2. The pace of fiscal tightening has raised the eyebrows of investors, who are fearful of the uncertainty surrounding the US economy. That said, unlike in the UK, there were indications that US inflation may have reached its peak during the quarter. Other economic data was generally mixed, with both US household and corporate balance sheets in a relatively strong position, although both services and manufacturing data recorded sharp consecutive monthly losses throughout the period. In the labour market, job growth remained stable and unemployment remained low, at 3.6%.
Europe was the second worst performing region during the period. Hope for a resolution or ceasefire of sorts in Ukraine faded during the quarter, as early talks failed to yield any significant agreement. The EU’s firm stance on the reduction of Russian oil imports heightened the risk of further energy supply disruption in the region. Eurozone headline inflation broke through 8% in May, albeit exacerbated dramatically by already precarious food and energy prices. Despite core inflation remaining at significantly lower levels than in the UK and US, pressure on the European Central Bank (ECB) to move away from their thus far dovish stance continued to build throughout the period. As with the US, there were consecutive monthly losses in both manufacturing and services industries. Job growth continued on its post-pandemic stable trajectory. In the markets, despite a high exposure to financials and energy sectors and a relative lack of technology names, the most influential French and German markets recorded losses of -11.32% and -11.29% respectively.
Japanese equities also suffered, although as we highlighted last quarter, weakness was again exaggerated in sterling terms by exchange rates. The historically cyclical markets broadly followed the pattern emerging from the US, albeit with more muted losses. Whilst the rising cost of living appears to be a global issue, the Japanese public have thus far remained relatively unscathed, with both the government and corporates opting to endure the brunt of the inflationary burden on their behalf. Despite coming under some pressure to address interest rates, the government opted to leave policy unchanged. Data released at the end of the period showed total worldwide production at major Japanese automakers in decline for a third consecutive month, citing a poor supply of parts from China. The depreciation of the yen added to the pain throughout the quarter, particularly given the relative strength of the dollar. In April, the exchange rate surpassed the $1:¥130 level for the first time in two decades.
After a tough first quarter for China, there were signs of significant improvement during Q2. We highlighted last time that circa 40% of Chinese GDP is derived from the digital economy, meaning that the global selloff had taken its toll on markets since January. We also reported that due to concerns surrounding new outbreaks of the omicron strain, the government had enforced their ‘zero-Covid policy’ by locking down parts of several major cities, leading to the closure of multiple manufacturing factories. The resultant period of economic slowdown that inevitably followed showed signs of reversal in Q2, through the encouraging reopening of schools and factories in major cities such as Beijing and Shanghai. However, despite the promise, investors remain cautious over the prospect of revolving lockdowns, particularly given that more than a third of the adult population are still not fully vaccinated. With this in mind, the government have taken further steps to encourage growth, through the cutting of a key interest rate for long–term loans as well as issuing a statement of intent to provide clarity on regulation in the technology sector imminently.
Largely due to the inclusion of China in Emerging Markets, the asset class performed relatively well despite the general risk-off sentiment among the investment community. In what was a mixed quarter, there were losses for net industrial metal exporters, such as South Africa, Brazil and Peru, largely due to fears of a lack of demand for materials from Chinese factories. Poland was another notable detractor, following Russia’s decision to restrict energy supply. Net energy exporters, such as Kuwait, Qatar and Saudi Arabia, offered some relative contribution, although gains made during April and May were eroded during June. Volatility and divergence between individual constituent countries remained the prevalent themes throughout the quarter.
Q2 proved to be another volatile quarter for bond markets. Broadly speaking, the defensive qualities usually offered by fixed income in times of economic difficultly have been largely missing this year to date. Continued high inflation levels and ongoing hawkish rhetoric from major central banks weighed heavily on the asset class throughout the period. Government bonds continued to sell off as interest rate expectations became a reality. Despite both retreating in May, the yield of the US 10-year Treasury finished the period 70 basis points higher, at 3.06%, with its two-year counterpart 65 basis points higher, at 3.00%. The two also briefly inverted again in April, as they had done a month earlier, indicative of a view among investors that there is a greater risk to the economy in the short run. To put the poor performance into context, the year to date returns of the US 10-year Treasury are the worst H1 figures since 1788.
The Fed followed its 25 basis point interest rate increase in March with two further hikes in Q2 – namely by 50 basis points in May and 75 basis points in June. The latter, which came in ahead of earlier expectations, represented the biggest increase in 28 years. Closer to home, the yield of the UK 10-year equivalent increased by 72 basis points to 2.33%. In response to soaring inflation, the Bank of England (BoE) continued to raise interest rates too, finishing the quarter at the 1.25% level. This not only represented the fifth hike since December, but also the highest level since 2009. We highlighted last time that, after months of adopting a more dovish approach, the rhetoric from ECB President Christine Lagarde had shifted to a more hawkish tone. In June, she unveiled plans to increase rates for the first time in 11 years next month. June also saw an emergency ECB meeting called to address the drastically widened spreads in the Italian government bond market.
Although government bonds marginally outperformed corporate bonds on aggregate, the asset class as a whole has suffered at the hands of significant interest rate rises, with those bonds with a higher duration (and thus more sensitivity to interest rate changes) having generally underperformed the most. Specifically in corporate bond markets, the best returns have typically come from investment grade bonds, i.e. those with a higher credit quality, as opposed to their more risky high yield counterparts.
The UK commercial property market continued its recovery from last year throughout the quarter. Whilst the growth rate slowed compared with Q1, overall investor sentiment towards the sector remained broadly positive – with the exception again being Real Estate Investment Trusts, which as listed equities, were negatively impacted by stockmarket volatility. As a major beneficiary of the easing of lockdown restrictions and social distancing measures at the beginning of the year, there have been signs that the property market recovery has continued to broaden out into sectors such as office and retail. Last quarter, we reported that the government’s ‘living with Covid’ rhetoric has led to a rise in footfall both in shopping centres and in offices, despite consumer spending remaining below pre-pandemic levels. Data released in Q2 indicated that retail footfall in April was 29% higher than a year previous, with the retail warehousing sector remaining a key contributor to the wider recovery. Whilst there were some signs that the recovery in the office sector began to slow in Q2, vacancy rates in London remain comfortably lower than the mid-pandemic peak. Figures released in May also showed that the London offices investment market recorded £20.3 billion of inflows in the year to April, significantly more than the £17.8 billion invested in the 2019 calendar year. As we reported last quarter, demand for industrial and logistics premises remains strong, with rising building costs expected to limit supply throughout H2. Notably, average industrial property valuations have recorded consecutive monthly gains since June 2020.
Viewing the asset class as a whole, the composite index returned 7.18% during the quarter. Unlike in Q1, where there was an even spread of returns throughout the quarter, Q2 saw positive contribution during April and May, but heavy losses during June. Broadly speaking, higher prices in both energy and agriculture offset the weaker performance of other commodities, such as livestock and industrial and precious metals. As we reported last time, already precarious post-pandemic supply levels of both energy and agriculture have been heavily impacted by the conflict in Ukraine, particularly given that Russia and Ukraine have historically provided circa 30% of the world’s wheat. The price of Brent Crude Oil finished the quarter at the $111 per barrel level, representing an increase of 6% during the period, despite recessionary fears threatening demand in the last few weeks of June. As Russia holds approximately a quarter of the world’s natural gas reserves, the ongoing conflict continued to heighten supply and storage fears throughout the period, with the price of natural gas reaching a 13-year peak in mid-June. We highlighted last time that our Investment Director, Amanda Tovey, recently wrote a commentary for our website, which explored the wider impact of the invasion of Ukraine on energy and agriculture.
Conversely, Industrial metals moved lower during the quarter, with declines in prices of nickel, aluminium, zinc and copper – the latter reaching a 16-month low in June. Concerns over demand for metals used for the production of goods grew during the quarter, as fears of a global slowdown in economic activity weighed on investor sentiment. Precious metals such as gold, silver and platinum also recorded losses in what was another volatile period. With central banks grappling with soaring inflation levels, investors have been concerned about aggressive interest rate policy, and have been typically opting for the US Dollar as the recent safe-haven asset of choice.
Given the economic backdrop and the resultant upward move in fixed income yields, the case for holding cash relative to bonds strengthened during the quarter. In the short-term, cash deposits insulate investors from the price volatility seen in other asset markets. However, in the long-term, the real value of cash deposits is likely to continue to be eroded by inflation. We currently only hold cash for short-term tactical reasons or within lower risk strategies, where the risk profile dictates a need for a larger cash allocation.
Whitechurch Investment Team
Quarterly Review, Q2 2022
(Issued July 2022)
Source: Financial Express Analytics. Performance figures are calculated from 01/04/2022 to 30/06/2022 net of fees in sterling. Unit Trust prices are calculated on a bid-to-bid basis OEICs, Investment Trust and Share prices are calculated on a mid to mid basis, with net income reinvested. The value of investments and any income will fluctuate and investors may not get back the full amount invested. Currency exchange rates may affect the value of investments.
Important Notes: This publication is approved by Whitechurch Securities Limited which is authorised and regulated by the Financial Conduct Authority. All contents of this publication are correct at the date of printing. We have made great efforts to ensure the accuracy of the information provided and do not accept responsibility for errors or omissions. This publication is intended to provide helpful information of a general nature and is not a specific recommendation to invest. The contents may not be suitable for everyone. We recommend you take professional advice before entering into any obligations or transactions. Past performance is not necessarily a guide to future performance. Investment returns cannot be guaranteed and you may not get back the full amount you invested. The stockmarket should not be considered as a suitable place for short-term investments. Levels and bases of, and reliefs from, taxation are subject to change and values depend on the circumstances of the investor.