It’s that time of year when Brokers, Analysts and Economists give expectations for the year ahead. Normally, that’s not so difficult but I haven’t seen such a varied series of potential outcomes and factors ever before. If there is a consensus at all, it is that some tough times await, with only a modest improvement sometime in the second half of 2023.
Inflation and energy
Inflation and rising interest rates are the kernel of current problems. Too many observers are likening this to the 2008-9 financial crisis but the external energy shock is much more akin to the 1973 oil price shock. Then OPEC engineered a fourfold price increase from $3 to $12 per barrel, which then doubled in 1979. The main difference between now and then, is that then OPEC kept the price high, so at least you could plan for the future. Today OPEC can only adjust volumes which leads to a much more volatile price level.
Cost push inflation fears mean the Government has been keen to stifle current public sector wage demands, so that the nurses claim for a 19% rise looks far too high. This is another variable with an unpredictable outcome.
Interestingly, some energy prices are already back to the levels before the Ukraine conflict but energy supplier hedging and purchasing planning means consumers and businesses will not see those benefits quickly. It’s odd that Government support measures are not reflected in any inflation figures and so by April inflation may be falling but ordinary people feel the full impact of energy price rises for the first time, as continued support is not guaranteed.
Interest rates are a main policy tool for Central Banks to restrain inflation back to the 2% target range. As inflation had exceeded 5% since November 2021 the bank has been playing catch up recently realising that the problem isn’t ‘transitory,’ as first stated. Here consensus, if there is one, is for 4.5% interest rates in 2023, but I have seen projections as high as 7% for the period. Again, a big range of outcomes.
Rising interest rates impact on many things including pension funds which were over geared with Liability Driven Investments (LDIs). The action the Bank of England took was really to provide liquidity in the Gilt market so pension funds could realise losses by selling Gilts. There was no effective bail out. However, Private Equity is worth keeping an eye on as they have enjoyed huge success with cheap money and been very competitive in the acquisitions field. An unknown risk factor, however, is that they are also involved in positions where financial institutions are both lender and investor, that might require bail outs, if things do go very wrong.
The length and outcome of the war in Ukraine is uncertain. If you are optimistic, it could be over by late Spring and Ukraine will recover all its territories, leaving a neutered Russia in its wake. The pessimists suggest it may go on for years as Russia just throws more and more men at the battlefront. Given the wide range of different implications and the benefits of the former, it seems surprising that the US does not provide the advanced weapons for Ukraine that would ensure a rapid end to hostilities. The so-called fear that Russia would escalate things further is an illusion. It is already violating every international rule of law by bombing the hell out of civilians. Going nuclear would also see it likely wiped out in short order and Putin knows that.
But Ukraine is not the only risk location. Tension is rising in the South China Sea, specifically over Taiwan, which has immense supply chain implications. India has flash points with China as well as with Pakistan. Then the Israel /Arab issues seem set to run further than ever and extend to Iran. Europe too, does not only have Ukraine to worry about, it has more tensions brewing in the Balkans between Serbia and Kosovo.
What does all this uncertainty mean for investors?
First the UK market remains cheap relative to others. It also has a low exposure to technology businesses, which is where most of the pain was in 2022. There are plenty of decent stocks on single figure PES but it will be important to avoid companies with high levels of debt, or those over dependent on acquisitions.
Similarly, the consumer spending over Christmas was highly funded by credit cards. This leaves a question mark as to what spending levels will be in the first quarter of 2023. Best to wait for a clearer picture. In this environment stick with any Index Linked investments but remember their real inflation linked value is only fully realised on redemption. Overall, watch the potential risk areas closely, before making decisions.
If you would like to discuss your current investments or future plans we would be happy to schedule a call – Contact details for the CFM team are here and my contact details are:
T: 07977 784167
Barrie Newton, January 2023