Hello and welcome to your July investor update.
I'm Tapas Sharma, head of brand design at Nutmeg.
I'm joined today by our director of investment strategy, Brad Holland.
Hi, Brad.
Hi, Tapas.
June was another volatile month for equity markets.
Can you run us through some of the key figures?
It was a negative financial market mood again in June
with world equities down almost 9%, to be down 20% year to date.
The UK's own larger company index, the FTSE 100
fell five and a half percent of the month
to be the best performing equity index year to date, down only 1%.
The key reason for the UK's better performance is a 10% depreciation in pound sterling this year
which has boosted foreign earnings of these UK companies.
In particular, the pharmaceutical companies.
It's worth pointing out that Chinese equities had a positive month,
up six and a half percent with that index now down only 10% year to date.
I say only 10% because in April it had been as much as 33% lower than its 2021 peak,
with Chinese tech companies in particular,
suffering from their Communist Party crackdown on data ownership.
Now the COVID lockdowns didn't help matters either.
So both of these negatives have been eased of late,
and Chinese stocks have retraced some of that loss as have wider emerging market equity indices.
So, what’s been behind these volatile conditions in June?
Well, world equities have seen four distinct periods of weakness this year,
each of them associated with rising bond yields.
And that was true in June.
Rising bond yields happened as bond prices fall.
So these episodes have seen both bond and equity assets lose value,
which makes it a very difficult investment environment.
Bond markets in all countries have weakened this year as central banks
seek to extricate themselves from the emergency easing conditions,
put in place since the 2008 crisis.
And extended more recently during the COVID crisis.
The policy intention had always been to create inflation,
but the policy makers have been taken aback by how much prices have actually risen.
Now, obviously, the supply problems post-COVID reopening,
and the food and energy price shock from the Ukraine conflict,
these have added to the inflation pressures,
and it's not all been down to monetary policy.
Given these conditions, did you make any changes to the portfolios
in the past month?
Yes, we we trained our excess exposure to US equities and UK mid-cap equities,
in favor of UK large-cap and Canadian equities,
both of which have large financial and commodity sector exposures.
And these markets are expected to benefit from tighter monetary policy
and the ongoing recovery in global trade,
particularly as China opens back up.
And on that front, we have removed our emerging markets underweight,
as we see several headwinds for emerging markets abating,
not least China's economy emerging from strict COVID lockdowns,
As bond yields have risen again to inflict further losses on bond holders,
we've also begun to adjust our underweight bond position.
We're still cautiously positioned in bond assets.
But but recognise that bond yields have risen significantly this year,
hence the partial rebalance.
We're halfway through the year and recession remains a very real possibility.
Though I understand it's not your base case scenario.
What's next for investment markets?
Stock market selloffs typically happen before economies enter recession,
and the roughly 20% loss in equities we've already seen,
would certainly qualify as a recession indicator.
Even if it doesn't guarantee a recession will occur.
But even if the data does go on to show recession over the next year,
that doesn't mean stock markets need to fall further.
No, not at all.
A key deciding factor there will be the outlook for inflation,
and this will determine how hard central banks feel they need to tighten policy,
in order to get underlying inflation back towards 2%.
You'll remember that the Bank of England governor Andrew Bailey,
said in February that the workers should should not seek excessive wage claims.
And that didn't go down too well then.
It seems this warning is being ignored by by large chunks of the labour market.
That brings us nicely to a client question.
A client asks, there seems to be a broad movement
for employees to seek wage rises in line with high inflation.
How would financial markets respond to this?
In principle, if wage rises of any size are linked
with productivity agreements, they will not be inflationary.
And this kind of wage rise is a win win, really.
The employee gets the higher income to match the inflation,
and the company gets the productivity boost, which benefits profitability.
And anything that benefits productivity and profitability, is good for equity markets.
But to the extent that wage demands set off a wage inflation spiral,
where employers seek to pass on the higher wage costs to their customers,
then those wage claims will be more economically disruptive,
not least because central banks will be forced to stop the spiral,
by much tighter monetary policy which will induce a recession,
in the demand for labour, which is rising unemployment.
Now, this idea of rising unemployment provides a good link to quickly remind ourselves,
of a key reason why inflation today is so high.
And the reason is that the massive support governments put into the economies,
in 2020 and 2021 to offset the impact of the COVID shutdowns.
A big part of the government policy was to maintain household income.
When many workers were threatened by unemployment due to the shutdowns.
The UK's furlough scheme was an obvious example of that, right?
Yes, that's right.
In the UK 12 million people had their wages paid by the Government.
Quite extraordinary.
So that massive cost of unemployment was avoided.
But, a cost hasn't been avoided altogether.
Incomes were protected,
but the ability of the supply side of the economy to deliver was not protected.
And that's something governments couldn't do.
They couldn't synchronize the restart of global production to perfectly match,
the pent up demand that had built up over the previous two years.
And so the cost we've eventually borne is a current spike in inflation.
The bond markets and all central banks view this result as inflation surge as temporary.
As do we here at Nutmeg.
So for a lot of people,
an alternative narrative, on the current period of price rises,
might be that this is a better price to pay than losing their jobs over COVID.
At least that's true for the 12 million people who receive furlough payments.
The key message Andrew Bailey was trying to get across in February
was that wage rises outside of productivity gains,
will ultimately lead to higher unemployment.
Which was a cost that the government sought to protect us from in the first place.
That's really interesting.
Thanks for your insight, Brad.
Thanks Tapas.
And thank you for joining us.
As ever, if you have any questions for Brad or the investment team,
or a topic you'd like us to discuss in next month's investor update,
you can contact us via social media, email or in the comment section below this video.
We look forward to seeing you next month.