The potential for further US dollar depreciation and a recession Stateside lead this month’s Investment Bulletin, but there are also striking opportunities in the UK market highlighted.
The factors potentially fuelling further US dollar depreciation against other major currencies are set out
Investors are warned to heed early signs of a US recession and the unlikelihood of markets being bailed out this year
Attention is drawn to what one manager sees as striking valuation anomalies among UK REITs and equities
The US Federal Reserve (Fed) does not expect to cut interest rates later this year, in contrast to market participants who do. The Fed may be considering the risk that inflation remains persistent in the coming years given that many large multinational companies have demonstrated pricing power since the pandemic. For instance, Unilever, a British-Dutch multinational company that produces everyday consumer staples, saw the prices for its goods rise by 10.7% from a year ago in the first quarter of 2023, though it has slowed from a peak of 12.5% in the third quarter of 2022i. This corporate pricing power could mean that inflation is stickier in the future.
The bottom line is that slowing US inflation raises the likelihood of the Fed pausing on interest rate increases. However, other central banks like the European Central Bank are likely to continue to raise interest rates given they were slow to start hiking. Higher relative interest rates in Europe will increase the attractiveness of the region, and we believe global investors are likely to move capital there as they seek out the potentially higher returns on offer. This could lead to further US dollar depreciation against other major currencies (i.e., the euro). Essentially, if there are more dollars available outside the US it reduces the systemic risk of a shortage of money dragging down asset prices. This happened during the Global Financial Crisis (GFC), as banks made fire sales of their assets to meet their obligations.
Higher relative interest rates in Europe will increase the attractiveness of the region, and we believe global investors are likely to move capital there as they seek out the potentially higher returns on offer. This could lead to further US dollar depreciation against other major currencies (i.e., the euro)
Higher gold prices also suggest the US dollar is overvalued. According to data that goes back 50 years, the US dollar reached a record low against a basket of currencies (US DXY dollar index) in March 2008, but it then recovered sharply during the GFC. Today, the US dollar is now coming down from a 20-year peak reached in September 2022 and could well depreciate further from here – see our December 2022 Investment Outlook. Ultimately, higher gold prices probably signify a weaker US dollar, which should provide a tailwind to drive the price of overseas equities and bonds.
Investment Strategist, Investment Management, at Evelyn Partners
Why do they “sell in May and go away”? Because if you have strong returns in the first four months, it pays to book them. This year might be a good illustration of the adage. Market movements since the October low have followed the textbook seasonality and might well continue to do so during the softer period.
Fundamentally, investors have favoured a very small number of the largest stocks in the world. Market capitalisation-weighted indices differ sharply from equal-weight indices. The top seven shares in the S&P 500 are up 50% year to date whereas the remainder of the index is down 6%. It is unlikely that this discrepancy will disappear amid the Artificial Intelligence discourse.
The Fed won’t bail markets out until inflation is below 3%, most likely next year, so equities may have to operate without a safety net for the next six months
More importantly, what could move markets this summer? Early signs of a US recession are looming with soaring jobless claims and less sticky inflation. The debt ceiling is a major risk. The 2011 episode resulted in a 16% drop in US equities in two weeks and it’s hard to imagine the US Congress today being more willing to compromise than in pre-Trump days.
US shares have been fighting not just the Fed but corporate earnings, despite bonds indicating a much worse outcome. The Fed won’t bail markets out until inflation is below 3%, most likely next year, so equities may have to operate without a safety net for the next six months. The safety net investors are talking about is gold, which is still helping portfolios, and wait for better valuations before becoming more bullish.
Director, Investment Management at Arbuthnot Latham & Co., Limited
It’s great that this month’s Investment Bulletin highlights the potential for further depreciation of the US dollar as I think that currency exposure is often an underappreciated risk. Indeed, it is something that many DIY investors neglect completely. We are probably not going to see the global de-dollarisation that some are warning of (or at least not quickly), but we should all be looking at our portfolios through the lens of the greenback’s dwindling strength to check we are ahead of any possible implications.
If you would like to carry out a health check on your portfolio, why not let us arrange some no-obligation discussions w with the leading advisers on our panel?
The late US economist J K Galbraith was of the view that “The only function of economic forecasting is to make astrology look respectable.” As the world moves on from historically low interest rates, this sentiment is hard to argue with. Nonetheless, there are valuation anomalies in the UK market that are so severe that one questions whether they can continue indefinitely.
Take REITs for example. While Home REIT is mired in scandal, there’s Triple Point Social Housing, a rental property investment with a 25-year index-linked rental agreement with housing associations, offering a yield of over 12%. If the underlying property asset were empty, it would likely sell for more than the current share price (47p). However, with tenants and the value of the lease taken into account, the NAV is reported to be more than £1. It’s worth noting that the company has fixed its debt at 3% for the next ten years. Social housing is a contentious issue, but it’s an under-supplied market with a long-term demand.
It is difficult to argue that such valuation extremes will continue indefinitely, and while some of the projections in these examples may prove to be erroneous, it is unlikely to be the case for all
In the oil industry, Serica, a North Sea producer, pays a 22p dividend that is expected to increase (and has done so in the past), on a share price of 220p. Net cash makes up almost 40% of its current market capitalisation of approximately £830m. Last year, the company added to its existing reserves through strategic development and acquisition, and unlike some of its peers, it is not a depleting asset.
In early-stage investing, IP Group is a 20-year veteran that has backed companies like Ceres Power and Oxford Nanopore. Its stock is trading at 55p, while its recorded NAV is more than 130p. The company has net cash in excess of £120m and is paying dividends while buying back shares.
It is difficult to argue that such valuation extremes will continue indefinitely, and while some of the projections in these examples may prove to be erroneous, it is unlikely to be the case for all. Plus, there are many other examples – these are merely the ones in clients’ portfolios!
Investment Director at Tyndall Investment Management
The investment strategy and financial planning explanations of this piece are for informational purposes only, may represent only one view, and are not intended in any way as financial or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.
We always advise consultation with a professional before making any investment and financial planning decisions.
Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.