Investment Update

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Article written by Iain Lightfoot, Managing Director, Armstrong Watson Financial Planning and Wealth Management and Richard Cole, Fund Manager at Future Money Ltd. Iain and Richard also host regular webinars called “Making Sense of Markets” where they discuss the factors affecting economies and markets. Our latest webinar was held on 6th May, please click here to watch the recording.

Our philosophy is to utilise active management solutions as we believe in the skill and judgment of professional fund managers to choose where to invest and have the ability to manage the underlying assets according to economic and market conditions.

Below we comment on a range factors including rising inflation and the challenges they pose to investment markets amongst others.

Bad News, a 40 Year Record

Inflation in the UK, as measured by the Consumer Prices Index, has reached 9%, the highest level since 1982. The previous month’s reading was 7%, with three quarters of the month-on-month jump due to the increase in the energy price cap in April.  The additional increase in these figures now means that the UK has the highest inflation rate in the G7.  While the figure was broadly in line with market expectations, and is no surprise given the Bank of England’s recent comments on projected inflation, the figure still has the ability to raise eyebrows.  The Bank expected that inflation is likely to peak at above 10% later this year, following the October review of the energy price cap. 

Cost of Living

Such high levels of inflation are likely to be temporary, with figures expected to fall dramatically in 2023, but in the intervening period, such rising prices are expected to cause damage to the economy.  The rising cost of living is damaging consumer confidence and spending on discretionary items is likely to suffer, as individuals see essential items taking up a greater share of their income.  It is this factor which is likely to lead to a fall in economic growth over the coming months, with a recession in the UK now being talked about as a very real possibility or even as a likelihood. 

Impact Reduced

Based on these points alone, doom and gloom appears the order of the day.  Yet, there are other indicators in the economy which are more positive.  While these do not counteract the recessionary forces headed our way, they are likely to reduce their impact.

Good News, a 50 Year Record

While inflation is at a 40 year high, unemployment is at 3.7%, a near-50 year low.  This shows that while concerns may be held over the direction of the economy, this is not yet stopping firms from taking on workers.  In fact, the number of job vacancies rose above the unemployment rate for the first time on record.  Clearly, this is only a measure of the current situation, while the worry surrounds what is coming our way, but with unemployment so low now, it would take a very large increase to become overly problematic at a national level.  The Bank of England expects that unemployment will rise to 5.5% as a result of the slowing economy and higher interest rates, but that is still a fairly low level on a historical basis.

This shows that while we are very likely heading for a more difficult time for the economy, it does not, at this stage, look dire. 

Profits Regardless of Inflation

The prospect of a recessionary environment will create concern amongst investment markets, and this can be seen by the volatility, and in some cases significant losses, seen over recent days and months.  But in a recession caused by inflation, there are still opportunities.  GDP (the most common economic growth measure) is reported in real terms, i.e. adjusted for inflation (growth excluding inflation).  Therefore with inflation currently at 9%, if GDP growth was to fall to 0%, on the brink of recession, then nominal growth (growth including inflation) would be at 9%.  This would suggest that companies are also making profits approaching double digits, on average.  Such earnings would not go unnoticed and therefore, where companies can continue to grow profits in spite of inflation, they are likely to see better performances. 

Relative Winners

Not all equities are equal, however, with some more able to generate inflation protecting returns, while others are less so.  In general terms, the US has more companies which struggle with higher inflation and higher interest rates (technology companies, for instance), while the UK market is better equipped (banks, energy and commodity companies) and this is one explanation for why the FTSE 100 has broadly held its value over the year to date, while the US’s S&P 500 has fallen by around 18%. 

A Challenge

That is not to say that UK equities will fully protect against inflation.  As the above figures show, returns are still below inflation, even if they are better than other equities markets.  This is a story that can also be seen in bond markets, with allocations to those less sensitive to rising interest rates proving beneficial on a relative basis.  Exposure to alternative asset classes with more explicit inflation links can help, such as in infrastructure, but with major asset classes struggling, to make money in this environment is therefore a challenge.  However, with patience it is a challenge that should be possible to meet. 

Looking Forward

While the coming months look difficult for the global economy, inflation is expected to subside significantly in 2023 and so cost of living pressures will reduce significantly.  At this stage, with unemployment still likely to be low by historic standards there is the potential for reasonable economic recovery.  Against this background, equities which will have continued to deliver profits in nominal terms through this period, should be rewarded, while bonds will no longer face such inflationary headwinds.  In this scenario, which we believe is likely, the prospects for investors would be much improved. 

Our Philosophy

Our philosophy is that no one can predict the peaks and troughs of financial markets with any accuracy and it has always been extraordinarily difficult to time when the best (peaks) and worst (troughs) are. Timing the stock market is extremely difficult, so we believe it is best avoided.

Volatility is a part of investing which is why we always take time to understand how much risk any client is prepared to take before investing. We also generally believe in the benefit of diversification of assets to help manage some of the extremes of the markets. Taking a diversified multi-asset approach means that some assets can fair better in different market conditions as they are more defensive assets such as bonds, whereas during periods of growth equities tend to fair better.

Armstrong Watson, in addition to our full range of accountancy services, also have our own fund management expertise from the Future Money asset management team, as well as independent expertise from the wider market. We are able to use this to help provide insight, commentary, advice and support to our financial planning and wealth management clients.

A key aspect of our investment philosophy is that it is time in the market not timing the market, which is usually the best approach. For more information and guidance on Investing, please download our useful Guide to Investing here.

At Armstrong Watson, our quest is to help our clients achieve prosperity, a secure future and peace of mind. We believe that for those people who are considering taking financial advice in relation to their savings and investments it may be a good time to do so to utilise existing allowances and tax reliefs.

Important Information

Please note that the contents are based on the author’s opinion and are not intended as investment advice. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested.

If you would like to discuss your investment portfolio please speak with one of our Financial Planning Consultants on 0808 144 5575 or email us.

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