The view from the bottom is much less alarming than peering over the precipice

01 June 2022

Lofty valuations have fallen along with equity markets, which means there is opportunity to be found. All we have to do now is identify those businesses that the public actually needs.
Let’s start with what looks bad on paper: There’s been a quarter of stagflation in the US. We’re very likely in a bear market; while markets have toppled 10% from their recent highs in weak GBPs, the strength of the US dollar takes this fall to an undeniably ursine 20%. Inflation sprints ahead while central banks have barely cleared the blocks as regards interest rate rises. UK consumers are most definitely worse off.
It seems clear that we are entering a downturn. What’s different this time around is the speed at which we arrived at this point in the business cycle. Not even a half year has passed since the bellwether Bank of England began inching interest rates up. The Federal Reserve quickly followed suit. But beyond that, there’s not a lot central bankers can do to ease the pressure. Stimulus checks are largely what got us into this mess in the first place. More money has been pushed into the system to be used to purchase goods, but production hasn’t expanded enough to enable that demand to be fulfilled. People are seeking to buy stuff that we are struggling to make. US productivity gains for Q1 2022 came in at an unsettling -7.5%.

This was probably the number that most shook the market in May, as ideally, it should always be positive. In recent years, we’ve seen investment in a lot of companies that don’t necessarily make us more productive. An example is Bitcoin exchanges like Coinbase: money moves from one person to another, but ultimately, it doesn't improve productivity, which means it cannot generate real growth. But it does generate inflation.
In summary, we need interest rate hikes to cool inflation. This will in turn reduce access to consumer credit (bank loans). As a consequence, consumers will start to focus on just buying the essentials. This economic environment demands a whittling down of those ‘theoretical’ businesses. In a downturn, companies need to be producing profitably to avoid being a drain on society's resources.
So what does that mean for us? The risk of recession is higher now. But investment risk is lower. Those extreme company valuations of 2021 have been cut right down. Now we can focus on identifying those attractive buying opportunities. The weight of averages suggests that while we may see further declines, we’re likely most of the way down already, and as a result, are comparatively more sure-footed. Our task is to figure out what to buy next in the event that things get worse. We’re playing defence now with allocations to property, infrastructure, short-duration credit and high-quality equities. We have to deal with the reality of what the data tells us. It's not about forecasting what's going to happen; it’s about identifying risks and trying to do the sensible thing now to give us options as the environment unfolds into the future.

Investment View: Cash in hand or in the bank? Inflation spares neither.

We’ve heard a lot about the ‘pent-up savings’ developed-world consumers compiled during their months of Covid quarantining. But today’s inflationary environment means leaving it in the bank could be just as corrosive as spending it on higher-priced goods.
Consumers and savers alike are being spared no breaks as the post-pandemic economic fallout progresses. A cost-of-living crisis is upon us. There’s a new hair-raising headline each week: UK inflation rocketed to 9% in April from 7% in March—the highest reading since 1982 and worse than the United States’ now-falling figure. In April, the government raised the energy-price cap (which dictates how much energy companies can raise their prices by) to £1,971. This resulted in gas prices increasing by 95.5%, and liquid fuel by a borderline perverse 113.9%. Despite the healthy balance sheets of UK oil majors like Shell and BP, the Office of Gas and Electricity Markets bumped it again (to £2,800) in late May, effective from October.
That example alone will see UK households on average £800 poorer come Halloween. The ghost of your disposable income will be further augmented by the rising prices of food and alcohol (roundabout 6%) as well as housing, which is knocking on the door of 20% increases.
Statistics tell us that a fair amount of people built up a healthy cache of cash throughout the lockdown days of 2020 and early ’21. Supposedly, UK savers are still much better off than they were pre-pandemic as a result of not being able to go out and spend regularly until very recently. Don’t get lulled by this comforting narrative. The truth is your cash savings are just as endangered as your disposable income.
Savings vehicles are simply not the safety net they once were. The fusion of searing inflation with stunted interest rates means cash in the bank will erode at a faster pace than ever before. As we’ve reiterated since the start of the crisis, you need to take a long-term view. In today’s environment, your cash savings is going to disappear, and quickly. A recent piece in The Telegraph estimated that holders of cash ISAs will lose approximately £784 per year as interest rates fail to keep pace with the rate of inflation.
The stock market is volatile by nature, but history shows that it almost always ultimately rises, recovering again and again from myriad geopolitical shocks. In fact, over a period of a decade or more, the stock market tends to outperform cash savings, as it generally outpaces inflation over that extended time period. A stocks and shares ISA is a simple way to start if you’re at the beginning of your journey. Alternatively, approach your Sanlam advisor about adjusting your portfolio; we’re currently favouring assets like defensive equities and short-dated credit. But break that cash out of the bank: your future self with thank you.
The information and opinion contained in this Monthly Commentary should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by Sanlam. Any expressions of opinion are subject to change without notice. Past performance is not a reliable indicator of future results. Investing involves risk and the value of investments, and the income from them, may fall as well as rise and is not guaranteed. Investors may not get back the original amount invested.

Phil Smeaton
Chief Investment Officer

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