Positioning for the energy price shock
Posted 11 March 2022
Global capital markets continued their wild ride this week, as market participants struggled to gauge by how much would Putin’s barbaric war on Ukraine dismantle their 2022 outlook for the global economy. Wild equity market swings are usually the focal point for investors when major upheaval occurs, but this time the oil price has been front and centre. The rising cost of energy has become the key economic variable derailled by Putin’s actions. This week we dedicate a separate article to what has changed (but also what probably has not changed) in terms of the medium-term outlook for the price of oil.
The diversified nature of the multi-asset portfolios Tatton runs for our investors means that the impact of market swings is somewhat softened. So, while several global equity markets have now declined by double digits for the year to date, as of Thursday this week our portfolios were down by between 6% and 9%. This is never good news for us; we are in the business of generating positive returns for our clients’ savings. However, after recent market resilience in light of the very worst imaginable uncertainties and shocks to the global economy as the COVID pandemic brought us, we have had much lower volumes of concerned investor calls than one would have expected only a few years ago.
In our view, such a ‘let’s wait and see’ attitude is wholly appropriate given the circumstances. Our longer-term investors and followers have learned over the years that markets are quite prone to overshooting and also that, once the dust settles, market positives always emerge. Given globally diversified multi-asset portfolios give investors access to the long-term growth potential of the entire global economy, then as long as we continue to believe this global economy will continue to exist and grow – just as we did two years ago – then we should believe portfolio returns will recover and continue on their gradual upward grind.
At Tatton, we started the year with a cautiously optimistic outlook, noting the backdrop of another post-lockdown surge in economic activity, but with central bank and government support on the wane, while persistent inflation was eroding household spending power. Despite the shock of Russia’s war on Ukraine, and the energy price shockwave it has brought us, much of this continues to hold true, although we have to accept that some element of our cautiously optimistic outlook will now suffer delays and may also be less pronounced, while there is also a risk of another brief recessionary period should the war drag on and/or central bank policy setters opt to fight energy price inflation with sharp interest rate rises.
Our positive medium-term economic outlook led us to look through the short-term slowdown caused by the omicron COVID wave. Our main concern was that the rise in fixed interest bond yields would continue, result in poor contributions from the risk-mitigating allocations to bonds in our portfolios. As a result, we maintained our equity overweight, not because we felt particularly bullish about equities, but because during inflationary periods, stock market investments provide the most effective defence against the purchasing power-undermining dynamics of price inflation. In such situations, equities become the only clear source of positive returns while bonds rebuild their contribution potential as yields rise.
Of course, and with the benefit of hindsight, we would have fared better had we held both an underweight to equities and Europe. Yet, as this week’s very significant rebound in European share prices has once again shown, it is fiendishly difficult to time such short-term market disparities and diversions without running the risk of losing valuable long-term growth potential.
As a result, we are happy our current portfolio positioning will achieve our goal of protecting investors’ portfolio values from the negative impact of inflation, while harnessing the most promising sources of return potential available in the current market environment.
This does not mean we have chosen to ignore risks that the economic environment could still fundamentally deteriorate and then necessitate repositioning portfolios to a more risk-off stance. We are closely monitoring how much the energy price cost shock will drive down projected corporate earnings as well as the likelihood that central banks might repeat their 1973 policy error of hiking rates rather than supporting the economy through a temporary rough patch. These headwinds will have to be weighed up against the likely tailwinds of the concerted public policy response to beef up defence spending, and much more accelerated fiscal investment initiatives into the energy transition project that not only reduce Europe’s energy dependency on Russia, but also the global dependency on fossil fuels that ultimately endanger the planet.
We have seen various investment indicators signalling that we may have reached ‘buy’ territory. However, we also know that when near-term uncertainty is determined by dictators, one should not count on the markets having completed their correction journey.
As such, for the time being we will restrict ourselves to the odd sub-asset class and regional repositioning through our set of overlay funds, while we conduct careful deliberations in our investment meetings to assess when the time will come to adjust course.
For those who need to make the decision to invest cash (or not), experience has taught us that a drip-feeding of cash into markets, when assets are available at considerable discounts, has been one of the most effective ways for investors to turn negative short-term volatility into long-term growth for their portfolios. Conversely, choosing to wait on the side lines until all uncertainties have vanished usually equates to considerable loss of opportunity.