Ahmer Tirmizi, Senior Investment Strategist at 7IM, tackles a range of wealth management issues many clients are concerned about today including, of course, the impact of the war raging in Ukraine.
Often, we like to take a temperature check of what’s worrying our clients – and give clear and direct responses. This time, there are some issues that we haven’t seen for a few years now, giving an indication of the changing global environment we’re facing.
We’ve tried to put it into context – but, as ever, let us know if you would like more detail.
1. What impact do you think the Russia/Ukraine conflict could have on portfolios?
We need to change the way we think about the world. Countries have done what was unthinkable. Putin has turned out to be more reckless, the EU has been more decisive and even Switzerland has tempered its neutrality. The scale of economic sanctions – both formal and informal – has been unprecedented. We have to accept that any of these could go even further.
Turning to the global economy, the two locomotives of global growth, the US and China, should be relatively insulated. The economic boost from the COVID-19 stimulus is still in effect and the US labour market is going strong. US consumers can absorb the oil price shock. Additionally, the evidence of pent-up new homes demand suggest the US economy can ride through the current uncertainty.
Equity markets are down, but overall, proximity to Russia seems to be the driving force for the uncertainty. Outside of Europe, the reaction seems more muted. For instance, Brazilian equities (also a commodity exporter) are up 25% this year. The long-term ramifications of the Ukraine crisis may not be negative for all
Equity markets are down, but overall, proximity to Russia seems to be the driving force for the uncertainty. Outside of Europe, the reaction seems more muted. For instance, Brazilian equities (also a commodity exporter) are up 25% this year. The long-term ramifications of the Ukraine crisis may not be negative for all.
2. Is rising inflation a continued concern and what could it mean for the broader market?
It’s easy to end up feeling that inflation will spiral out of control. Instead, we believe inflation will settle in a range of 2-4% over the next 3-5 years. That doesn’t mean there won’t occasionally be higher or lower numbers during that time. Right now, the current crisis is pushing us to the upper end of that range, but we expect that to come down again.
Inflation between 2-4% will be enough to encourage economic dynamism, but not enough to damage the economy. Part of the inflationary impulse will come from rising wages, which should help dampen the impact of inflation on people’s costs of living
Inflation between 2-4% will be enough to encourage economic dynamism, but not enough to damage the economy. Part of the inflationary impulse will come from rising wages, which should help dampen the impact of inflation on people’s costs of living.
However, the biggest impact won’t be on “Main Street” but is more likely to happen on Wall Street. The market is priced in a way that expects the last decade of sub-2% inflation and sluggish growth to continue. We don’t think this is the case. The implications are clear – rotate portfolios away from last cycle’s narrow winners and towards a more diversified set of asset classes.
3. It has been so long since the world has experienced inflation above 2%, what do you think will be the ramifications on 7IM’s ability to beat inflation?
Taking a step back, we need to remember that some inflation is a permanent feature of our lives. Economies adjust, policymakers react, and markets re-price.
And 7IM have always built portfolios assuming that there will be a reasonable level of inflation. We do so by making inflation-protection a key building block of our Strategic Asset Allocation, alongside interest rate exposure and economic growth.
Many investors associate growth and inflation, assuming that you can’t have one without the other. However, there are plenty of examples of high-inflation, low-growth environments. There are also plenty of low-inflation, high-growth periods, with the last decade being a prime example.
Many investors associate growth and inflation, assuming that you can’t have one without the other. However, there are plenty of examples of high-inflation, low-growth environments. There are also plenty of low-inflation, high-growth periods, with the last decade being a prime example
We want to make sure our portfolios are ready for all kinds of environments when constructing them. We do this by incorporating real-time measures of CPI as well as oil prices into our portfolio construction process.
All of this is to say that the SAA is deliberately built to deliver above-inflation returns over the long term, in line with what our clients need.
This piece certainly reflects the myriad worries investors are bringing up in their conversations with us. There’s no doubt that there are a lot of things one could be worrying about presently but, as is also emphasised here, investors can breathe a lot easier with an expert adviser backed by institutional research on their side. If you are finding it difficult to pick through all the noise to discover actionable investment insights (and who isn’t?), perhaps it’s time to consult the professionals? We can set-up initial conversations with a shortlist of best-matched firms in no time, and at no cost to you at all.
4. What makes a value stock vs a growth stock? What are the tailwinds and headwinds for the former?
Roughly, value investors look for established companies with a proven business model and cashflows that are undervalued by the market. They are prepared to wait for the market to come to its senses.
Growth investors want to invest in business models that might not make money now but have the potential to make big profits in the future. They’re willing to pay more than a company and then wait for the world to change and for it to benefit.
In our view, it’s easier to think about cyclical and non-cyclical companies.
There’s a big overlap between cyclical companies and value companies – the most unloved investments of the last few years have tended to be cyclical
Cyclical companies are exposed to the economic cycle. When the world is expanding fast, the earnings of cyclical companies grow. Banks, energy companies, miners, airlines, railroads, and manufacturers are good examples. These might be value investments, but they are cyclical companies.
Non-cyclical companies are the opposite. They tend to have business models that have steady, recurring revenues, and make money regardless of economic trends. Classically, these have been utilities companies, healthcare and consumer staples – but more recently has included technology companies too, as they’ve become more embedded into our lives.
There’s a big overlap between cyclical companies and value companies – the most unloved investments of the last few years have tended to be cyclical.
5. We saw most developed equity markets have a rough start to the year – do we anticipate that this will be the theme for 2022?
The “rough” start to the year had little to do with Russia and Ukraine. Instead, investors found themselves start to tear themselves away from the large tech companies, reacquainting themselves with the rest of the market. This rotation caused some market volatility.
But since then, the news has been dominated by the current crisis. So far, the market is trying to discriminate as fairly as it can between companies with Russian exposure and those without. Largely it’s done a decent job, which has meant hat European equities aside, the market reaction has been contained.
6. Why have ESG strategies struggled recently, relative to the broader market, and how long do we see this persisting?
There are three reasons why ESG strategies have struggled since the start of the year:
- Firstly, the rotation from non-cyclical to cyclical is particularly troublesome for ESG strategies. ESG strategies and screens often favour non-cyclical companies which typically rely on low-emission technology rather than more capital and resource-intensive business models.
- Secondly, recent spikes in oil and gas prices have been short-term headwinds. Investors have rotated away from long-term energy winners, such as wind and solar, into the old-world energy producers. The idea of energy security is offsetting some of this though.
- The final is the underperformance of healthcare stocks so far this year – pain which we’ve felt across portfolios where we have a long-term tactical allocation to healthcare, where ESG strategies tend to be overweight.
These stocks are in key sectors that will support the world in fighting climate change and in many cases, government regulation, changing consumer preferences and technological change will steer capital towards these companies and lead to outperformance over the long term
Many companies in the areas outlined above are now trading at a significant discount to the rest of the market. These stocks are in key sectors that will support the world in fighting climate change and in many cases, government regulation, changing consumer preferences and technological change will steer capital towards these companies and lead to outperformance over the long term.
7. Boris Johnson has had a difficult start to 2022. How important is UK politics for portfolios?
The last few years have been a roller-coaster in UK politics – one pandemic, two referendums and three prime ministers.
It’s natural to worry about how a sterling-based portfolio, with all these ups and downs, should fare. The answer is, quite well. The reality is that exposure to the UK is very small – less than 10% of a balanced portfolio.
7IM portfolios are globally diversified, meaning they are more linked to the ups and downs of the global economy. UK politics, quite simply, doesn’t matter much.
The past performance of investments is not a guide to future performance. The value of investments can go down as well as up and you may get back less than you originally invested. Any reference to specific instruments within this article does not constitute an investment recommendation.