A sharp U-turn has changed the landscape
2022 has felt like four seasons in one day. Shock events have quickly changed the investment landscape and the most recent, the mini budget, has caused further avoidable volatility. We thought that the government would likely need to reverse course and we have seen moves in that direction.
A change in Chancellor has helped restore confidence, and a credible fiscal plan combined with changes in policy to stimulate growth will help further. Regardless we feel there will be an "incompetence discount" on UK assets in the short term. Faith in His Majesty’s Government is low, and a further change to leadership could be needed to draw a line under this blunder until the next election.
Markets have been volatile in recent weeks
The mini-budget introduced a much higher level of volatility into markets than we have seen in recent years, even with the pandemic having had a big impact since 2020. Markets had been trying to find an equilibrium point to price in the effect on the economy and asset prices, with many areas of UK markets falling in comparison to other parts of the world as a result.
With the installation of a new Chancellor and the announcement of a U-turn on the vast majority of Kwarteng's policies from the emergency budget, we believe that some of this volatility will lessen in the short-term. However, we have seen different reactions to this sharp change from different segments of the market, with bonds reacting quicker than equities thus far.
Bonds reacting quicker to economic slowdown
The government bond market has been more reactive to the ongoing reassessment in economic fortunes and has fallen much quicker than equities over the past year. This is a rare and ‘odd’ event where lower risk investments have fallen more than the growthier elements of a portfolio.
We believe that bonds are reacting to a change in conditions that will lead to a recession, while equities will react to the recession once it gets here. The dislocation between bonds and equities is not a fundamental change in the risk of these assets but reflects a different sensitivity to the sequence of events.
While bonds are not immune from falls, historically they have been more stable than equities over longer periods of time and the good years offset the weak years. In the last 22 years equities have fallen in 6 annual periods. In 5 of those years, bonds have held up when equities have fallen. With bonds falling faster than equities in the current market, will the new fiscal plans of Jeremy Hunt be accepted by the market, or will it throw it into further turmoil?
A risk-off solution could be needed
Are bonds right, and equity markets wrong, or vice versa? Or are they estimating the market cycle at different rates? One thing we know is that rising rates slow the economy, creating more risk in portfolios that are more aggressively positioned.
At FE Investments, we look to provide investment management expertise so that advisers can spend more time with their clients to help them achieve better outcomes. This means that we aim to manage risk in our portfolios and aim for a stable level of performance over the long term, looking to offset risk of volatile markets and negative market events.
Our portfolios cover a wide spectrum of outcomes to ensure clients have enough choice of the types of investments they’d like to make. Our Hybrid, Income and Mosaic portfolios emphasise risk management, where ESG factors are part of the process but the objective is not such a high priority. In contrast, the Responsibly Managed portfolios combine sustainable and impact funds together, and delivers a more progressive outcome to do more good. By doing so, we can target a broad client base and help advisers advise their clients effectively.