The war in Ukraine puts the spectre of a worldwide energy crisis front and centre for investors. The news flowing from the embattled nation is awful to see, yet two months on Ukraine’s defiant stand continues to frustrate Russia, which commands vastly more troops, supplies and equipment.
Investors expect central banks to deliver a whole bunch of interest rate increases
The conflict has exacerbated already rapid increases in inflation and prevailing yields. The 10-year UK government bond yield soared from 0.97% to 1.61% over the quarter, and then pushed above 1.80% in early April. The rise of the US 10-year was even more dramatic: from 1.51% at the dawn of 2022, it finished three months later at 2.35%. At time of writing, it had surpassed 2.80%.
Investors expect central banks to deliver a whole bunch of interest rate increases and reverse their quantitative easing schemes, perhaps more tightening than is indeed possible.
The rapid rise in bond yields has benefited our Societe Generale VRR Index Structured Product, which we first bought in late 2021 and added to earlier this year. This note makes money if the volatility of US Treasury yields rises; if yields just amble along with little movement, we lose money.
We have used higher yields to slowly increase our bond holdings at better interest rates, as we have avoided them as much as possible in recent years because they offered virtually no return.
price-earnings multiples have retreated to roughly to where they were before the pandemic
Meanwhile, price-earnings multiples have retreated – to an average of 19x in the case of the S&P 500 Index – roughly to where they were before the pandemic upended markets back in 2020. Put plainly, investors want much higher returns for lending money or putting up equity because of the foggy future. Even as company profits are actually growing at a fair clip.
Reboot the mainframe
Investors are finding it extremely difficult to weigh up shorter-term risks with longer-term opportunities. This is leading to some pretty bizarre moves in share prices. Some stocks have dropped 10% in the morning, and yet finished the day 10% higher than where they started. That’s barmy. But, mad as it is, it creates plenty of opportunities for us to trim winners and pick up bargains as we rebalance carefully and often to keep our portfolios prepared for rough waters ahead.
The Ukraine war has taught Europe an important lesson about energy strategy and security
One of these new stocks was American stockbroker, ETF provider and wealth manager Charles Schwab. The company is growing well, driven by its compelling zero-fee approach to execution-only accounts. Charles Schwab makes most of its revenue from the interest earned on cash in client accounts, so it is actually an interest-rate beneficiary in disguise.
The Ukraine war has taught Europe an important lesson about energy strategy and security. But it will take more than a few years to put right. In the meantime, soaring prices for gas, petrol and electricity are squeezing everyone.
The effects are so widespread that the World Bank cut its global 2022 GDP forecast to 3.2% from 4.1%. Households and businesses have broadly come out of the pandemic flush with cash and a hankering to spend. But a sustained increase in costs will rein that optimism in eventually.
We do, however, appear to be at peak inflation freak-out for expectations, so we sold some of our US Treasury Inflation-Protected Securities 0.125% 2024 to take profits. The amount of future inflation implied by the price of these bonds is the highest since at least 2003, ergo the value of TIPS is very high.
Trust in Jeff
The pall of uncertainty hanging over the future leads us to focus on ensuring our portfolios are ready for whatever jumps out of the gloom. This year is looking like it will be a tough one for households, businesses and some governments. Because of this, we are focusing our investments that have little debt, make a lot of cash and have products and services that are hard for their clients to pass up.
cash equals flexibility…it gives managers options
Strong cash flow really is so important for companies, especially when economies start to slow. Put bluntly, cash equals flexibility. It gives managers options: the ability to invest in promising ventures or take out struggling rivals for a song, to pay down debt or take on more at reasonable rates. These businesses have the best chance of coming through difficult situations unscathed – and sometimes even stronger.
While we’re prepared for short-term pain, we note there’s a chance of things turning out better than people expect right now. Prices in bond and stock markets suggest people are anticipating a royal flush of bad stuff. Yet the Citi Economic Surprise Index, which measures actual economic news against expectations, has risen sharply this year showing that so far the reality hasn’t lived up to the nightmares.
When the news is jammed full of war and inflation and pandemics it can lead you to think the world is going to the Inferno in a shopping trolley. But these things have plagued us before and, sadly, will again. People can be terrible, yet only a fool would bet against human ingenuity in the long run. To paraphrase the immortal Jeff Goldblum, humanity finds a way.
David Coombs is Rathbone multi-asset portfolios lead fund manager