Navigating today’s market volatility is possible with strategic investment — but don’t underestimate the “inflation monster”, writes Will Wainewright, founder of Alternative Fund Insight
It is the worst year for bond returns in almost a century and equities have been pummelled. War has raged on the edge of Europe and an inflation crisis has torn through the global economy like a rip current.
Keeping up with the sheer quantity of news can be difficult at times. But money managers have an even greater challenge: how to invest strategically amid such chaos in markets and geopolitics.
Taming the inflation monster with strategic investment
Understanding the importance of US inflation in shaping global market outcomes is key to navigating volatility, according to Kleinwort Hambros.
“What happens to US inflation is by far the most important thing in any market right now,” says Fahad Kamal, the private bank’s chief investment officer.
US inflation sits near double digits, provoking an aggressive series of Federal Reserve rate hikes, which in turn has strengthened the dollar this year.
Initial reasons for higher US inflation related to commodities and the energy complex — motor fuels, electricity and more — where prices are now coming down.
But US inflation has “metastasised” into other areas of the economy says Kamal, speaking at a discussion entitled “Resisting the Inflation Monster”.
This is largely due to salaries being bartered upwards in a tight labour market.
“That is what scares the Fed more than anything else,” he says.
Some in finance expect the US central bank to “pivot” and ease off its rate increases to avert a recession which most now believe inevitable. Kamal is unconvinced.
“They must make sure that this genie is put back in the bottle. That is difficult to do when inflation is so broad-based.”
The importance of US inflation has been underlined by the UK’s recent political and economic crisis.
While Liz Truss and Kwasi Kwarteng’s tax-cutting “mini-budget” sparked the spike in gilt yields, the Bank of England is widely considered to have been too complacent in the face of the UK’s double-digit inflation.
Interest rates were low compared to the US and sterling vulnerable against the greenback before it was sent to a record low of $1.03. Gilt yields soared as investors took fright.
“The UK has been punching above its weight in global volatility, given the size of our economy,” says Kamal, highlighting the country’s dubious achievement of headlining global bond market activity.
It began to be seen as a systematic risk issue, briefly overtaking US inflation as the dominant market theme.
The shredding of most of the tax cuts by new chancellor of the exchequer Jeremy Hunt seems to have reassured markets — for now.
‘Worst is over for the pound’
Kleinwort does not believe sterling, which has partially recovered against the dollar, will plummet again.
“The worst is probably over for sterling,” says Kamal. “We have partly reflected that in our portfolios, which have been very dollar heavy.”
“At these levels, not only is weak sterling causing problems for the UK, but the eurozone; because import prices rise,” he adds.
“Such a strong dollar is also causing problems for the US. Most companies do not want such a strong dollar — half the earnings of the S&P 500 come from abroad.”
He expects that if the dollar gets any stronger there will be a coordinated global central bank initiative, similar to the 1985 Plaza Accord.
The firm is positive on the UK stock market, which is now “very attractive” in valuation terms, adds Thomas Gehlen, senior market strategist.
Strategic investment management
The UK aside, how else is the firm strategically positioned against the backdrop of a macro environment as “uncertain as they have seen in decades”?
Kleinwort is underweight equities, but highlights that if the Fed can engineer a soft landing, bringing down inflation without a severe recession, it will be a “positive environment for risk assets”.
“Only time will tell,” says Gehlen. “For the time being we are in a slowdown regime, albeit a very uncertain one.”
US stocks remain priced slightly above long term averages, which he calls “somewhat concerning”.
Their general attitude is to take a prudent approach with maximum diversification.
Kleinwort’s increased holding of diversifiers includes cash, gold and hedge funds, which “have been an amazing diversifier” for them this year.
“In the aggregate our hedge funds are up,” says Kamal.
The firm has also started allocating to real assets and has an in-house offering to which most of its funds are allocated.
“We have shied away from for a long time due to the challenges of investing in the asset class,” says Gehlen. “It brings diversification, a yield and a degree of inflation protection.”
Growing exposure to infrastructure includes investments ranging from electricity grids and bridges to supermarket property, undersea internet cables and correctional facilities.
“In the UK we’ve got great mechanisms to get exposure to [real assets] with investment trusts,” says Gehlen. “They tend to be able to hold illiquid assets within a fairly liquid wrapper that we can hold in a diversified portfolio.”