Quarterly Investment Newsletter: Spring 2021

Mon 19 Apr 2021

Rising concerns for the prospects of inflation dominated the first quarter of 2021 and caused bond market yields to rise in both the US and the UK. As a result, US treasuries lost over -5% of their value (in Sterling terms) during the period, whilst the loss on gilts was even greater at just shy of -7%. Though some had feared that rising bond yields might undermine the lofty valuations on equities, stock markets continued to rely on the gradual emergence from lockdowns in some parts of the world to support optimism resulting in global equity returns of over +4.6%, again in Sterling terms. The US again led the way with returns over +6%, with the UK not too far behind at +5.4%. Gold, which had offered considerable protection during the sell-off a year ago, continued to struggle even in the face of rising inflation expectations, losing over -10% in the quarter.

The case for rising inflation has solid foundations, and perhaps the bigger question is whether the world sees a short-term bout of transitory inflation or a more established pattern of price rises extending into the medium term. Inflationary pressures can broadly be sorted into three areas. Firstly, the frictional effects of the Covid-19 pandemic and the associated disruption to global supply chains. Secondly, an expectation that (some) consumers have cash burning a hole in their pockets and will want to spend it once lockdowns ease. And finally, that in addition to well established loose monetary policy, fiscal expansion is now a significant force, at least in the US. Companies are already reporting an increase in the prices they are having to pay across their supply chains, and we suspect that consumer psychology and willingness of governments to continue spending beyond the pandemic will be crucial to determining what type of inflation the world sees, and for how long.

Support for the economy in both monetary and fiscal forms remains necessary to prop up the economy which is still hampered by the effects of the pandemic, and we think that the danger of stimulus being withdrawn too quickly is an unlikely risk. We do though expect to see differing approaches to government spending around the world and don’t necessarily expect President Biden’s recent stimulus package to be imitated in other countries, particularly in the EU. Similarly, divergences in monetary policy are starting to become evident with the US Federal Reserve and the Bank of England seemingly unconcerned with the recent rises in yields, whereas by contrast the European Central Bank will look to ward off tighter financial conditions.

Underpinning all other considerations is the market’s continued optimism for the reinvigoration of the global economy as the worst of the pandemic passes. This is of course a brave assumption, particularly given the difficulties of vaccine supplies, the scale of the global vaccination program required, and the possibility of virus mutations. Challenges in this area might give markets cause to question current valuations.

At our April meeting the Investment Committee voted to make changes to our portfolios which move closer to our new strategic asset allocation. These changes include a greater weighting to overseas equities (with some currency hedging) and a move away Sterling denominated debt towards a more diverse range of bond investments. Within our tactical positioning we hold the view that what worked well last year may not do so this year, and therefore favour the UK geographically, and have increased our weighting to ‘value’ stocks.

-David Baker, CIO