Chris Leyland, True Potential Director Of Investment Strategy, looks back on the key themes around the True Potential Portfolios over the past month.
As part of our commitment to transparency, we always share the rationale behind the decisions we make when managing the True Potential Portfolios.
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The backdrop has been challenging for asset classes as we move through 2022. Volatility remains elevated. At True Potential, we are long term investors, believing that diversification is essential to facilitate the achievement of long-term client investment goals.
Our near-term outlook remains one of caution, but opportunities continue to present themselves. Supporting factors include:
- Low unemployment with labour conditions remaining tight.
- Resilient consumer demand – the development is the pivot from the consumption of goods to services.
- Strong reported profits from Q1 and generally healthy corporate balance sheets.
- Economic growth rate slowing but market forecasts pointing to a healthy level with global GDP growth predicted just above the 3% level for 2023 and 2024.
As we look into 2022 we observe the following:
- Current high inflation rates should peak but settle higher than desired by hawkish central banks.
- The rate of economic growth is slowing – global recession is not our base case, but risks have increased.
- Central banks are raising interest rates at a time economic growth prints are cooling.
- Global supply chains remain constrained by the War in Ukraine and China’s zero-covid policy.
Whilst not all new, these are challenges for economies, consumers and markets. The True Potential Portfolio team and Investment Manager cohort have been managing this changing environment through the moderation of equity exposure and adjustment of styles within our Portfolios. This includes the rotation from cyclical sectors towards those with greater pricing power, defensive characteristics and those exhibiting lower volatility than their respective index. Specific examples include a move towards the Healthcare sector and additions to the Minimum Volatility Equity products.
So far this year equity weightings in our models have reduced, for example within TPP Balanced they have reduced 2% ytd. When allocating to managers we continue to favour those with exposure to alternatives assets and very recently fixed income has increased, with 3% added to global sovereign bonds.
Below we will build out further our views
Importance of China easing the zero-covid policy
The Oxford Coronavirus Government Response Tracker COVID-19: Stringency Index – Our World in Data indicates stringency levels in China remain high at 79 out of 100. This compares to the UK with a score of 13. The approach taken by the Chinese government is having an adverse impact on retail activity, industrial production, and economic growth (4.8% Q1), which is lagging annual targets of 5.5%. We have seen gradual steps from the People’s Bank of China to support financial conditions, however, there are a series of points that may encourage a change in direction. A key one being an appetite to achieve economic growth targets and a desire to enter the fourth quarter Communist Party Conference with a tailwind of suportive economic data prints, which are factors not to be underestimated.
Inflation in the US will peak in the near term
No significant change in view during the month. Still anticipating US inflation will peak in the first half of 2022 and for the UK and Europe to peak towards year end. Post peak, inflation globally will remain stickier, exacerbated by the demand for services, wages given the tight supply of labour leading to increased demand and shelter costs (US CPI).
Economic growth is moderating but from high levels
Economic growth remains supported by strong corporate and household balance sheets, an effective desire to spend / invest aided by tight labour markets and supportive financial conditions. Whilst we see economic growth moderating, a US recession in 2022 is not our base case.
There are regional nuances, the UK and Europe face higher recession risks driven by headwinds to growth. In Europe, the dependency on Russia for much of its oil and gas is problematic as sanctions intensify. In the UK, the increase of the Ofgem price cap on energy in October will put further pressure on the UK consumer.
Our view is evolving to be less negative on fixed income
We have seen a significant increase in sovereign bond yields since the start of the year and the True Potential manager cohort are starting to view the yield offered as becoming attractive. We do believe if Central banks are successful in containing inflation this will increase our appetite to extend duration.
In credit markets, spreads which reflect the compensation offered for holding corporate bonds over government have continued to widen (global investment grade corporate bonds spreads moving from 100bps at the start of the year to 150bps). Valuations are starting to become more attractive. However, before adding, greater comfort is required on the compensation for recession risk. We are conscious that liquidity in lower rated credit can be an issue and the asset class remains volatile.
Financial conditions in the US can tighten from here
There has been an acceleration in the tightening of financial conditions, key drivers being equities falling, credit spreads widening and US dollar strengthening. Whilst at this stage, financial conditions are not overly tight vs history; they are creating pressure points. The Fed will tighten further, undeterred by this challenge, as they focus on containing inflation. In this environment, the US dollar is likely to remain supported in the near term.
Building on this view, Sterling remains undervalued on a purchasing power parity basis. Given the headwinds to the UK domestic economy and differential in Central bank policy expectations, it is difficult to see this changing in the near term.
Company earnings are robust
As we move through earnings season, results have generally been strong, except for a few well reported misses. In the US, a consensus of analysts expect to see 9% earnings growth for 2022. The TP manager cohort believe this is bullish, expecting mid-single digit earnings growth. In the current environment, we favour companies with strong pricing power and healthy balance sheets.
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