Economic Commentary – July 2022


The world is facing wide range disruption and distortion.  Seemingly all areas, countries, and economies are being affected.  The tail end of the pandemic, the War in Ukraine, the mismatch in supply and demand in energy, global food insecurity, rising inflation, rising interest rates (and falling living standards) are all being pushed to the surface at the same time.  Central Banks will have to grapple for some time, with inflation, a problem which they haven’t had to manage for many years. 

We are seeing different Central Banks react different, with the US and UK steaming ahead with interest rate rises, the ECB and Japan have been more modest in their approach.  And with the recovery in China about to start, the Chinese Central Bank, are moving to a looser monetary policy!

Just one of these global issues may be a struggle to deal with, but all at the same time is unprecedented.  Blue, Red or Other the world needs great minds and vision - Global leaders, policy makers, global institutions, businesses, and ordinary consumers need to grapple with fundamental changes to society that has benefited so much for so many, over the last 50 years. 

Long-standing clients will be aware when we talked about the “4 horseman” what we thought could hamper growth in the years ahead (increasing debt, ageing populations, increased robotics, and offshoring of jobs).  These could very well be joined by a fifth – social unrest.  As global GDP has continued to increase, people fail to share in the increased prosperity.  When nurses need foodbanks, we have a problem.

At the time of writing, in the UK we are witnessing the largest train strike since the 1970s with talk of Nurses, Teachers and other Unions balloting.  This is being threatened and replicated across the world, in different sectors and industries.  Just recently in the United States, we have seen workers form a Union for Amazon and Starbucks, despite the best efforts of these companies to challenge them.   The Times They Are a-Changin’

We are taking this opportunity to highlight and discuss, some of the areas that the world needs to deal with, to halt a return to the 1970s troubles.

“History never looks like history when you are living through it. It always looks confusing and messy, and it always feels uncomfortable.’’ (John Gardner, 1968– Former US Secretary of State of Health, Education and Welfare).

 

  1. Just in Case manufacturing

We spoke in January 2022 about the difficulties the world was experiencing with the Just in Time (JIT) supply chain.  The JIT supply chain had for several decades been the bedrock of global trade.  With continuous improvement, it helped eliminate waste, increase efficiency and productivity globally.  Then, the pandemic and the war in Ukraine have massively disrupted the global system.  Businesses and industries are now faced with highly volatile resource prices, shipping costs have increased, well established supply chains in China have buckled, and there are large swings in consumer behaviour and consumption.  Companies are having to hold additional resources and products, as they are unsure on whether they can source new materials, and what price they will have to pay, as it changes day to day.

Just in Case manufacturing is the antithesis to Just in Time production. Very much a traditional method of production, where companies will hold reserves of both raw materials and finished products to be able to respond to increases in demand.   Companies are having to look local and increase the number of suppliers on their books.  For decades manufacturers used increasing globalisation and supply chain to drive efficiency and create lean processes that helped them growth and remain competitive.

We may now be seeing this era pass or diminish, with increased disruption and volatility for global trade becoming normal.  This will increase cost, reduce productivity and profitability.  Consumers should expect less choice and less access to products, the longer the supply chains remain stuck.

 

  1. Ukraine

There are no winners in war.  What we are witnessing in Ukraine, whichever side claims victory will not compensate for the terrible and inhumane loss of life. 

 

  1. Environment

In the wake of COP26 in Glasgow, governments globally were more prepared to look at how climate and environmental change will affect future growth.  According to the Swiss Re Institute, “by Mid-Century, the world stands to lose around 10% of total economic value from climate change”.  Modelled on a scenario where current temperature increase remain on their currently trajectory, and global governments do not meet both the Paris Agreement and the 2050 net-zero pledge.

Environmental and climate impact will be a huge threat to economic stability.  Heatwaves reduce productivity.  Hurricanes, cyclones, flooding etc. lead to clean up bills that run into the tens of billions.  Droughts and the destruction of arable land further complicate how the global food supply chain can function.

We have spoken before, that a considerable amount of private and public capital will need to be directed towards sustainable growth.  Clean energy systems, smarter urban developments, sustainable land use, water management and sustainable industry (recycling) may very well be the industries of the future.  This isn’t for government alone, and the problem needs public and private sector collaboration to change the way we produce and develop sustainable economic growth.

Decarbonisation will likely increase costs in the short term, as businesses and industries adapt their models with less reliance on fossil fuel and with sustainability as a key driver.  Inaction will likely lead to reduced prosperity, in the long term.

 

  1. Covid

Following the Omicron wave in late 2021 into the early months of 2022, Covid seems somewhat behind us for now.  But elsewhere, the policy response is somewhat different.  China, the engine room of the world, that has led global growth for the last two decades and helped the world out of global recessions is still insisting on a zero Covid strategy.

This is causing further disruption to global supply chains; shipping containers and costs as entire cities and regions are placed in rolling lockdowns and policed quarantine.  As the vaccination progress has stalled, it is likely that the zero-approach will continue to create difficulties throughout 2022 and into 2023.

The virus is not going to be eradicated.  New variants will continue to rise and spread, but we are now in a better situation as vaccine efficacy holds.

 

  1. Debt

The $226 trillion elephant in the room (IMF Global Debt database).  Increasing global indebtedness will eventually begin to weigh upon economic growth.   Of course, during the dark times of the pandemic, where governments used Central Banks to fund furlough and support business, this was very much about saving the global economy.  Central Bank policy was to kick the can as far down the road as possible, but with interest rates now increasing across the world, the weight of this debt will start to bite.

  • Businesses refinancing old debt will find it more expensive, limiting their ability to invest and grow
  • Consumers’ disposable income will reduce as mortgage and credit card payments increase
  • Political pressure will force National Governments to curtail spending on large projects

At the time when businesses and governments will be looking for cheap access to finance, the door may be shut.  Which could curtail growth in the short term.

 

  1. Anti-Capitalist Sentiment

Jean Jacques Rousseau, an 18th century philosopher was once reported to have said, “When the people shall have no more to eat, they will eat the rich” a phrase that has now become popular with the millennial generation.  And who can blame them?  In their lifetime, they have seen housing pushed further out of reach, zero hours contracts, the gig economy, multiple market and system failures, student loan debt increasing year on year, and the full brunt of austerity placed at their feet.  A survey by the thinktank the Institute for Economic Affairs (IEA) states that 80% blame capitalism for the housing crisis, while 75% think the climate emergency is specifically a capitalist problem and 72% back sweeping nationalisation.  In just 15 years, the average age of the first-time buyer has increased from 28 to 34 and this has consequences. Family life starting later, delayed career progression and changing spending habits.

Sooner or later, this sentiment could take hold in mainstream politics, which would profoundly change the entire economic system.  The proponents of free market capitalism need to better explain and help develop understanding of just how much good the system has done in the world.  Capitalism has fueled the industrial, technological, and green revolutions.  Reshaped the natural world and transformed the role of state.  It has lifted innumerable people out of poverty and increased living standards beyond anything imaginable just 200 years ago.

Without great minds and leaders stepping forward, we face further political instability, with the risk of further populist leaders from all divides, stumbling, bumbling, and lurching from one crisis to the next.

 

Where are we?

It is often difficult, when in the deep fog to find your way out.  Action or inaction, optimism, or pessimism, it is difficult to know which way to turn.  The Stockdale Paradox considers this very problem.  Admiral James Stockdale was a prisoner of war in Vietnam for 7 years, who survived incredible suffering, with no end or release date in sight, when his other colleagues did not.  Known now as the Stockdale Paradox, he spoke that those colleagues who were too optimistic in the beginning, were weighted down with disappointment, and those who were too pessimistic gave up.

“You must never confuse faith that you will prevail in the end—which you can never afford to lose—with the discipline to confront the most brutal facts of your current reality, whatever they might be.” — Admiral James Stockdale.

Despite the difficulties we have talked about above, the world has boundless potential!  We appreciate that there are so many competing factors in play, but when they are resolved, we have spoken previously on just how fast paced the world is moving.  We are likely to experience more progress in next decade than the 100 years previous!    More and more complex automation, processing, digital infrastructure, Artificial Intelligence, Biotechnology, future of clean technology – managed correctly, the future looks incredibly bright. For the next 6 months the Investment Committee are positioning the portfolio as follows:

 

Cash – Highest

Despite our concerns with rising inflation, we are still recommending clients hold a high cash position. We are looking to protect against two different risks, volatility and inflation. As risk managers, taking a higher cash position, allows us to add further to positions in equities, while overall keeping clients within their agreed risk parameters.

 

Loans and Debt – Lowest

We are keeping Loans and Debt at the “lowest” levels within client comfort zones. Lending to governments or companies does not appear attractive to us in 2022.

With Central Banks across most of the world, raising interest rates, we are concerned with capital erosion. We are recommending that the bulk of these assets are invested with Strategic Bond fund managers, who have the tools available to them to navigate choppy waters with a small allocation to renewable infrastructure debt where appropriate.

 

Property – Mid Point

We are relatively comfortable with the holdings in the property asset class.  With the bulk of the allocation split between UK and Overseas Infrastructure.

 

Mixed – Mid Point

We are retaining a 1/3 strategy into a mix of strategies as a ballast against equity and bond volatility.

 

UK Equity – High

We are maintaining a high weight to UK Equity, but we are reducing UK Small Cap exposure, in favour of FTSE 100 companies.

 

Overseas Equity – High

We are maintaining a high position in Global Equity.  Considering the size of the market, we are still holding positions in Gold, Developed World, Thematic Investing, Resources and Smaller Companies. 

We are reducing the allocation for Emerging Markets from Neutral to Low and moving the allocation to Resources.  With The US increasing interest rates, it will likely strengthen the dollar further against Emerging Market currencies, which will make it more difficult for these developing economies to service their debt obligations.  We are moving the allocation to a Global Energy Transition strategy, which looks to capture the upside opportunities as the world looks to move away from Carbon to Renewable.

Past performance is not a guarantee to future performance and the value of investments and income from them can fall as well as rise.

This article has been written for information purposes only and does not represent personalised advice.






Article published: 03/08/2022

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