August 2022

August Investment Summary

Investors focus returned to the difficult backdrop of slowing economic growth, interest rate rises, elevated levels of inflation, and the ongoing war in Ukraine. The “risk-off” environment saw global equity markets erasing nearly half of the gains made in July. Bond markets continued to adjust for more hawkish moves by global central banks, resulting in fixed income markets (Europe and UK in particular) posting their worst monthly returns of the year so far. In the currency markets, the pound sterling had another horrible month sliding to 1.15 against the US dollar.

The problem for the central banks, and financial markets in general, is that inflation is running at levels last seen in the 1980s. Interest rates are still too low to have any impact on bringing inflation down towards the target rate of between 2% and 3%. Of the major central banks, the US Federal Reserve (Fed) has been the most aggressive, but even they have only pushed rates up to just over 2.25%. Fed Chair Powell was very explicit in a speech at the Kansas City Fed’s Jackson Hole conference that it was not yet the time to pause rate hikes. Neither equity nor bond markets took this news well. US ten-year yields are edging back up towards 3.5%. This has pushed mortgage rates up significantly and begun to noticeably slow the US housing market. A housing slowdown is often a precursor for a larger economic slowdown. Indeed, housing affordability in the US is now at 2006 levels.

Whilst inflation is a global problem, the Eurozone and the UK have greater challenges ahead than most. The sharp rise in energy prices, in particular natural gas, has impacted them more because of their reliance on Russian supplies – see Appendix 1. Both central banks face a tough task balancing the sharp rise in inflation and the reduction in economic activity in the face of these price shocks and the impact the direct impact this will have on businesses and household incomes.

Central banks are hesitant to hike rates too much in a slowing economy. But their currencies’ exchange rates are suffering as the Fed has been more aggressive. It is a mess. The European Central Bank has suggested that a 75-basis point hike may come in early September. Some members of the Bank of England’s Monetary Policy Committee have suggested they also need to “go big”! As I write, Liz Truss, the new UK Prime Minister, is advocating tax cuts and other spending measures to combat the energy shock. This won’t make things any easier for the Bank of England.

The recent move by Russia to turn off the Nord Stream 1 pipeline has set Europe up for a difficult winter. Talk of rationing energy and factory shutdowns have bounced around asset markets. None of the above is good for equity markets. This also puts further downward pressure on the exchange rate which puts further upward pressure on inflation. This is not a good place to be.

China isn’t helping the global economy either. The ongoing Covid-19 lockdowns continue to wreak havoc with global supply chains. The slowdown in real estate is also dampening consumer sentiment and demand. The only good thing about China’s slowing growth is that it isn’t putting any upward pressure on energy prices. Thank goodness for small favours.

Not losing is winning, so being conservative is not a bad thing. For the first time in many years (perhaps a decade?) cash offers a decent nominal return. Sure it doesn’t protect you from inflation, but declining equity markets haven’t protected you either. In the US, 6-month T bills pay nearly 3.5% and, in the UK, two-year gilts also pay over 3%. We may hold a bit more of these in the portfolios as we navigate through what is likely to be a challenging finish to the year.

Jeffrey Brummette

Chief Investment Strategist

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