Quarterly investment review - Q3 2022

By Gavin Haynes

As we go into the second half of 2022, we look at how different asset classes and stock markets have been performing, which funds and sectors have been the winners and losers over the past quarter and what are the key themes driving markets.

As we go into the second half of 2022, we look at how different asset classes and stock markets have been performing, which funds and sectors have been the winners and losers over the past quarter and what are the key themes driving markets.

The challenges facing investors continued to increase during the second quarter with inflation, rising interest rates and the Ukraine war remaining key concerns. To add to the negative sentiment, the effect of these factors on consumer and business sentiment is starting to see a slowdown in global economic growth. The spectre of stagflation with elevated levels of inflation and recession across Western economies is now looming large.

Asset classes

The past quarter has been a torrid time for investing as the inflation shock has caused turmoil to the economic backdrop. The latest monthly figures released showed the UK Consumer Prices Index rose by 9%1, whilst US inflation reached a 40-year high of 8.6%2. These elevated levels of inflation have led to further tightening of interest rates from key central banks over the past month. Central bankers now appear in consensus in admitting that the economic shocks we have seen will mean the environment of low interest rates and stable inflation that has been with us since the 1990s is unlikely to return for some time.

The question now is how much damage will be caused to economic growth through trying to control inflation. As we go into the second half of the year, we are facing both high inflation and a slowdown in the global economy, as the cost of living drags on economic activity. This move towards stagflation has seen investors become increasingly risk averse and global stock markets fell heavily during the quarter with the MSCI World Index plummeting by 14.3%.

Government bonds has traditionally acted a safe haven during periods of falling stock markets, but this has certainly not been the case this year, as bonds have sold off due to the inflationary shock. For example, the Bloomberg Global Aggregate bond index has fallen by 8.3% during the second quarter of 2022. If inflation continues at high levels, it will remain a headwind for bond markets. However, if concerns of recession become more pronounced, then bonds may return to favour.

The current environment has certainly justified the argument to diversify an investment portfolio further than the traditional mix of equities and bonds. Commodities is one asset class that has bucked the downward trend in 2022. The inflationary environment has primarily been driven by a shortage of supply in commodities, particularly energy due to the war in Ukraine. The oil price increased during the second quarter with the Bloomberg WTI Oil Price index rising by 9.0%. However, towards the end of the quarter there were signs that the slowing economy was tempering the upward price rises.

Alternative asset classes such as property and infrastructure have also provided more defensive characteristics in the inflationary environment. However, gold lost some of its shine over the past quarter and the price fell by 7.9%. The gold price has been broadly flat this year, but has lost money in real terms (i.e. when adjusted for inflation) and not provided the safe haven that investors may have hoped for in a period of inflation. With interest rates rising, the opportunity cost of holding gold increases (given it provides no yield) so the outlook for the precious metal remains predictably unpredictable!

Regions

It has been hard to find anywhere to hide across global stock markets during the past quarter as investor sentiment has become increasingly negative. The US stock market has been at the forefront of the sell-off. Many of the leading technology stocks that led the market rise have seen heavy falls over concerns for their earnings potential in a more difficult economic backdrop. The S&P 500 index fell by 16.2% and is now in a bear market.

The UK stock market has proved more resilient than most global markets this year with high commodity prices bolstering oil and mining shares that are a key component of the benchmark index. But the CBOE UK All Share index fell by 4.8% in the second quarter as concerns of slowing economic growth began to affect these economically cyclical areas towards the end of the period.

European stock markets have fallen heavily as their economies are at the epicentre of the energy crisis caused by the Russian invasion of Ukraine. The benchmark MSCI Europe ex UK index fell by 10.5%. However, Asian markets proved more resilient and although the Japanese Topix index fell by 3.7%, this proved to be the pick of the major developed markets.

Asian economies are not suffering from the same level of inflationary pressures as Western economies, whilst the main positive during the past quarter was an improving Chinese economic outlook, as government stimulus and an improving COVID-19 outlook boosted investor sentiment. The MSCI China index was the only area to produce a positive return of 4.5% in the quarter. Following a torrid twelve months, are we seeing the green shoots of recovery for Chinese equities?

Finally, whilst it has been tough for most equity strategies, the past quarter has continued to be more favourable for Value investors than Growth investors. Although the MSCI World Value index fell by 9.6%, this was half as much as the MSCI World Growth index, which fell by 19.6%. The Value versus Growth debate remains a key conundrum in the uncertain backdrop. The economic environment of rising inflation and interest rates has seen a resurgence of Value investors, but the economic slowdown may provide more support for quality Growth stocks. It seems clear that given such an unpredictable backdrop style diversification makes sense!

Tillit universe


The past quarter has been rewarding for investors who have taken a contrarian stance to invest in Chinese stock markets. The last year has been a difficult time to invest in China, with COVID-19 affecting the Chinese economy and government regulation spooking investors. However, the past quarter has seen bargain hunting investors take advantage of cheap valuations. Fidelity China Special Situations was the best performer in the Tillit universe during the quarter, rallying by 14.5%, and the Matthews China Smaller Companies fund came second, rising by 5.2%.

In such a gloomy economic backdrop it has been very difficult to find areas to protect an equity portfolio. However, defensive areas of the economy such as insurance and healthcare have been returning to favour. Polar Capital Global Insurance managed to grind out a positive return of 1.5%. This specialist fund invests in companies in the insurance and reinsurance space, focusing on best-in-class, proven, companies, where underwriting is absolutely key. Irrespective of the economic climate, people continue to pay their insurance premiums and the prices seem to continue to rise, making it a good inflation hedge. Healthcare is another area that traditionally does well in a cyclical downturn and Polar Capital Global Healthcare Trust produced a positive return of 1.0%. This trust favours more defensive areas of the sector such as pharmaceuticals, as opposed to the higher risk area of biotechnology that has seen significant falls in recent months.

Finally, despite the fall in the gold price, one of the best performing funds in the Tillit universe this quarter was the iShares Physical Gold ETC, which returned 1.4%. The reason for the disparity is that gold is priced in US dollars and sterling investors benefited from the rise in the US dollar during the period. It has proven resilient due to the relative strength of the US economy and the aggressive interest rises in recent months and it has performed particularly well against sterling. This has helped buffer losses in funds holding US dollar-denominated assets.


At the other end of the spectrum, it has been another difficult quarter for Scottish Mortgage Investment Trust, whose share price fell by 30.1%. The mangers of this investment trust (Baillie Gifford) look to exploit long-term themes that are going to be the drivers of disruptive change. Examples include digitalisation, the energy transition and ground-breaking development in healthcare. This approach to Growth investing has resulted in exceptional long-term returns for holders of this investment trust. However, market conditions this year have provided a very difficult backdrop for Growth investors. As investors have become risk averse, they have shunned more adventurous areas of the stock market. Scottish Mortgage Investment Trust has also been hit by the uncertainty over the value of its unlisted holdings which make up a material part of this strategy. Baillie Gifford Positive Change has suffered in a similar way, losing 22.3%. It follows a similar approach to hunting long-term Growth themes with an added sustainable investing angle to its philosophy, but it doesn’t have exposure to unlisted holdings.

In a similar vein, private equity investment trust, Pantheon International also suffered in the quarter.

Montanaro European Smaller Companies Trust was also hit hard with the share price falling 28.6% as investors remained nervous of European investments due to the war in Ukraine, and its style of investing in Growth businesses remained out of favour.

Perhaps more surprising is the appearance of Jupiter Gold and Silver, which fell by 22.3%, driven by a sell-off in gold mining shares as investors questioned whether precious metals can provide an inflation hedge as interest rates rise.

Looking ahead

It is hard to sugar coat the short-term investment backdrop given the headwinds that will continue to face markets in the coming months.

The market seems to be pricing in further interest rate hikes in an attempt to combat inflation, but it feels increasingly challenging for Central Banks to control inflation without stifling economic growth further. Markets will continue to monitor Central Bank activity which will be a key driver of short-term asset prices.

Perhaps the one positive is that negative sentiment is already embedded in asset prices and stock markets are already pricing in a gloomy economic outlook. So although the coming months are likely to remain challenging, periods of negative short-term sentiment can provide opportunities for investors who are taking a long-term view in their portfolios.

During difficult investment backdrops it is important not to panic or try to implement your investment strategy based on short-term cyclical trends. Bear markets can offer opportunities for long-term investors and as the legendary investor, Warren Buffett said ‘be greedy whilst others are fearful’.

Sources: FE Analytics (quarterly performance figures for funds and market 31/03/21 to 30/06/22). Qualitative commentary from Tillit meetings with fund managers.
1https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/april2022#:~:text=The%20Consumer%20Prices%20Index%20(CPI,of%200.6%25%20in%20April%202021.
2https://www.cbsnews.com/news/inflation-cpi-consumer-price-index-may-2022/

Date of publication: 15 July 2022

The information in this post is not financial advice, it is provided solely to help you make your own investment decisions. If you are unsure about whether an investment is appropriate for you, please seek professional financial advice. You can find more information here.

When you invest you should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future return.

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