WeekWatch -‘Equity markets followed a familiar pattern last week to the past few months’ May 2021
Equity markets followed a familiar pattern last week to the past few months. Investors were focused on news about rising inflation, and prices were slightly more volatile in response to evidence that it is growing as successful vaccination programmes allow economies to re-open. Stock markets in the US and UK ended the week slightly lower, although the US S&P 500 Index remains close to its all-time high.
The prospect of higher inflation has been generating more headlines in recent weeks. UK inflation more than doubled to 1.5% in the 12 months to April, according to recently released data (see In the Picture below). Meanwhile, consumer prices in the US rose 4.2% over the same period. The prices of certain commodities, such as lumber, have risen in recent months as the world economy has begun to re-open and demand has surged.
One of the most pressing questions on investors’ minds right now is whether the higher inflation that is currently taking place will be short-lived, or whether it will keep rising to the point that it prompts central banks around the world to lift interest rates. Low interest rates, plus other forms of support from central banks, have been positive for asset prices since the pandemic took hold and have helped to support markets since they were stepped up last year.
“We don’t have a crystal ball as to what’s around the corner, but as investors we just need to assess the range of probabilities. And it’s clear that there has been a shift in the balance of probabilities compared to when the positive vaccine news emerged in November. Since then, both the MSCI World and S&P 500 have risen,” wrote Johanna Kyrklund, Chief Investment Officer at Schroders and manager of the St. James’s Place Managed Growth fund.
She added: “So, the potential upside remaining has probably shrunk, while the potential downside has grown. The odds aren’t as attractive now, but it’s too early to be overly defensive. There is no recession on the horizon; you need to stay invested and you can’t sit in cash.”
On Wednesday last week, the Federal Reserve published the minutes of its most recent meeting on the subject. According to the release, its members believe that the bank should soon discuss “a plan for adjusting the pace of asset purchases”. That announcement appeared to act as reassurance that the US central bank is in no hurry to immediately cut back its support.
Of course, when fund managers are building their portfolios, they take into account a wide range of future possibilities. A period of higher inflation is just one of the potential scenarios that they weigh up when selecting which investments to make. For example, Hamish Douglass, co-founder of Magellan, which manages the St. James’s Place International Equity fund, believes that his portfolio is well-placed to deal with a new investing environment.
He expects inflation to be a drag on the share prices of ‘cyclical’ businesses, which tend to perform well in times of economic growth. It may also be a drag on the more speculative stocks (such as innovative technology businesses) whose share prices have soared over the past year.
“Around 50% of our portfolio in invested in defensive, high quality assets. That could be businesses like Nestle and PepsiCo, or it could be McDonald’s. Those assets tend to do very well when markets get scared. It’s why, when markets go down, our strategy tends to protect people’s capital so well. It hasn’t been the best place to be in the past four months, but I’ve got a lot of confidence that the structure of our portfolio will give a lot of resilience,” he added.
Magellan and Schroders are fund managers for St. James’s Place.
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