Looking for the stag in stagflation - Rathbones
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Issue 31 —
First quarter 2022
Looking for the stag in stagflation
Although consumer prices have been rising rapidly, they’re likely to fall back
this year and the risks of entering a period of stagnant growth remain remote
In brief
Not all geeks are American
The movers and shakers of
the future could be anywhere
Growth vs value?
The quality and visibility of
company profits are what matter
Net zero growth
Will the green transition help or
hinder economic expansion?
Paying down the debt
Beware the growing pile of gilts as
the UK’s credit card bill comes dueForeword
The final quarter of 2021 proved to be an eventful one for the global economy,
with surging inflation and ongoing concerns about supply shortages. Yet markets
performed relatively well over the period despite the new Omicron strain adding to
the uncertainty. As we look ahead to 2022, economic indicators suggest the post-
COVID recovery should continue, and so too should earnings growth.
Our lead article looks at the buzzword of the moment — stagflation. As investors’
fears of the potential stagnation of output coupled with rising inflation ebbed
and flowed, equity and bond markets experienced some volatiliy. What will this
uncertainty mean for the year ahead?
On page 5, we look at the domination of the markets by US-based tech firms, as we
ask if all the geeks are American. Where should we look to for the next wave of tech
innovation (and investment opportunity) — and is it necessarily going to come from
across the pond?
After the initial wave of selling amid the first lockdowns in March 2020, global
equity markets have been on a more or less upward path, but leadership has shifted
from one style to another. But rather than focus on styles, such as ‘growth’ versus
‘value’, we explain why we think the best approach is to look for companies with
quality and durability of earnings growth, whatever style category they might fit into.
On page 8, we explore whether the transition toward a world of net-zero carbon
emissions will boost overall economic output or hinder it. There is hope that it could
have a net positive effect, but governments and business need to start taking action
now to avoid a more disruptive transition.
Lastly, on page 9, we focus on the UK’s large ‘credit card’ bill, as pandemic related
borrowing starts to come due. Having borrowed more in the 2020/21 fiscal year than
at any time since records began in 1946, more of this debt will have to be absorbed by
the market if the Bank of England starts to wind down its purchases of gilts this year.
That’s one of a number of factors that make us cautious about UK gilts.
We hope you and your family remain healthy and safe. We also hope the new year
will bring more of a return to normal, including the chance to meet and collaborate
once again. In the meantime, we will continue monitoring how the investment
environment is evolving as the world reopens and we start to see what the ‘new
normal’ looks like. Please visit rathbones.com to find out more about our latest views.
Liz Savage and Ed Smith
Co-chief investment officers
2 rathbones.com InvestmentInsights | Issue 31 | First quarter 2022Looking for the stag in stagflation
Inflation is high but the pace of
economic growth isn’t stagnating
Global equity and bond markets had a bumpy end to 2021 as investors began to fear
the worst of both worlds — stagnating output and persistently rising inflation, that
nasty combination called stagflation. While we do think inflation will begin to fall back
from the spring, there is considerable uncertainty around its outlook. However, fears
of stagnating growth look overdone.
We see encouraging signs for equity Looking for the right signal flattening but still upwardly sloping yield
investors in purchasing managers indices The yield curve has started to flatten curve denotes a sub-par environment
(PMIs) of global business activity and again (financial market shorthand for that should cause investors concern.
other leading economic indicators. a narrowing difference between the Since the relationship is not a linear
In general, they remain strong and yields on longer versus shorter-dated one, many analysts (including us)
consistent with continued momentum US Treasury bonds) and some investors transform the signal sent by the yield
in company earnings growth. These are citing this as a reason to be negative. curve into a probability of recession
indicators are moderating from their That’s because it’s seen as signalling using what we call a non-linear model.
extreme highs as economies initially rate rises in the short term and slowing Even in September, after a summer of
roared back to life from pandemic- growth further down the line. However, flattening, the yield curve still suggested
related shutdowns. But we are a long a flattening yield curve is not on its own a 0% chance of recession according to
way from stagnating growth, much less a cause for alarm. this model.
contraction. The relationship between yield
As the post-COVID recovery enters curves and the business cycle — or GDP
its next phase of expansion, we think growth or stock market returns, for that
business investment is likely to be matter — is not linear. After the yield The yield curve has started to
a driving force. Both in the US and curve flattened over the summer, an flatten again (financial market
worldwide there is evidence of a strong argument was floated along the following shorthand for a narrowing
pick-up in business capital spending lines —the yield curve is flattening, it difference between the yields
(capex) plans. As well as preventing may invert next. While an inverted curve
stagnation, this factor is also likely to (when longer-dated yields fall below
on longer versus shorter-dated
ease inflationary pressures. short-dated yields) tends to be associated US Treasury bonds) and some
More and better tools lead to with impending recession (figure 2, investors are citing this as a
enhanced productivity growth; better overleaf), that doesn’t mean that a reason to be negative.
productivity puts downward pressure
on unit labour costs; and unit labour
costs tend to correlate with core inflation Figure 1: Unit labour costs and inflation
(figure 1). Minutes from the latest Wage inflation tends to correlate with core inflation, represented here by the Fed’s favoured
meeting by the US Federal Reserve (Fed) Personal Consumption Expenditure (PCE) measure..
have also noted anecdotal evidence of Unit labour costs (annual change, %) Core PCE inflation
the increased use of automation by many 15
businesses in the face of ongoing labour 12
market shortages. 9
Equity investors can also appeal to
6
history for some level of comfort. Profit
3
margins nearly always expand during
periods of economic growth (with sales 0
going up by more than costs). In addition, -3
since the turn of the last century, profit -6
growth has only failed to beat inflation 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
during the great depression of the 1930s Source: Refinitiv, Rathbones.
and in 1910. Past performance is not a reliable indicator of future performance.
InvestmentInsights | Issue 31 | First quarter 2022 rathbones.com 3Looking for the stag in stagflation
In fact, because yield curves start of rate hikes in the US, UK and Europe. companies with persistent momentum
to flatten mid-cycle, a recent study in Both the Bank of England and the Fed in generating good-quality, growing
the Journal of Investment Management made surprisingly hawkish changes to profits makes sense, irrespective of
(JoIM) found that flattening is actually policy in December and bond and equity styles. Strong earnings momentum
associated with a more stable growth markets were unperturbed. can be found in both value and growth,
environment — that’s good news for cyclicality and defensiveness, and
investors, not bad. Keeping an eye on earnings these more ‘top-down’ macro factors
Another crucial lesson to heed is Still, our relative optimism shouldn’t are likely to be a less relevant source of
that the window between inversion lead us to be complacent about the differentiation.
and recession tends to be long, 14 to 15 many challenges facing investors in the In the US and other major markets,
months on average, and has been getting year ahead — after the blistering gains in average earnings continued their streak
longer with time. This makes it harder equity markets coming out of the worst of comfortably beating expectations
for investors to use the yield curve as of the pandemic, it’s likely to be a difficult in the latest quarterly results, though
a signal, as equity markets only lead year by comparison. One major challenge guidance on future earnings was
recessions by three to six months. Selling will be to work out where the next leg of more cautious than expected. Supply
equities as soon as the curve inverts growth is going to come from, while also chain disruptions and labour supply
could cause you to miss out on rising navigating the supply chain and labour shortages could also continue to
stock prices for rather a long time, let market disruptions and government debt weigh on profit margins and need to
alone selling them when the curve starts burdens that the pandemic is leaving in be watched carefully on a case-by-case
to flatten. its wake. basis. Still, though caution in the face
We would be cautious about having of uncertainty is warranted, the bar for
Regaining some balance any significant bias toward a particular earnings expectations in 2022 may now
The big worry for 2022 is the potential style, especially highly valued ‘growth’ be set sufficiently low to limit the risk of
trade-off between growth and inflation, companies or ‘cyclical’ shares that are disappointment.
for a corollary of 2021’s growth bonanza more sensitive to broader economic
has been steeply rising prices, as we’ve conditions. Both of these could come * www.rathbones.com/knowledge-and-insight/
quarterly-investment-update-surprisingly-stellar-
noted in this quarter’s Investment under pressure if bond yields resume 2021-and-unusually-uncertain
Update.* US inflation has reached a three- their rise or the economy stutters. There
decade high — UK inflation is likely to do has been relatively little differentiation
the same in the spring — and there is an between these and other investment
unusually wide fan of possible outcomes styles this year, which is typical in the
from here for investors to be alert to. middle of the economic cycle when the Our relative optimism
Overall, excess inflation is primarily initial spurt of growth has peaked.
shouldn’t lead us to be
about the unusual composition of In the article ‘The quality and
spending. Consumer goods inflation rose visibility of company profits are what
complacent about the many
in line with spending on goods. Demand matter’ on page 6, we explore more about challenges facing investors in
here has fallen sharply, and it is difficult why we think a ‘bottom-up’ focus on the year ahead.
to see how consumer goods inflation
could stay elevated for too long without
the demand. Figure 2: The yield curve and recessions
High inflation in consumer goods While an inverted curve tends to be associated with impending recession, that doesn’t mean a
is unlikely to fully pass over to high flattening but still upwardly sloping yield curve is a reason for investors to be concerned.
inflation in services as spending
normalises. Our base case is for global 1–year to 10–year yield curve US recession
4
inflation to fade meaningfully from the
3
spring, but to remain elevated until at
2
least 2023. Much depends, however, on a
1
resumption of normal spending patterns,
which could be stalled by Omicron. 0
Central bankers have been clear that –1
there is little they can do to stem the –2
unique causes of today’s inflation, but –3
that they are more mindful to tighten –4
1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017
policy as output and employment are
strong. Rising rates would ordinarily be a
Note: The difference between 10-year and one-year US Treasury yields is used here to represent the yield curve
headwind to valuations, but markets are Source: Refinitiv, Rathbones.
already pricing for a substantial number Past performance is not a reliable indicator of future performance.
4 rathbones.com InvestmentInsights | Issue 31 | First quarter 2022Not all the geeks are American
The movers and shakers of
the future could be anywhere
We often get asked if US equities are in and stock market leadership. For long- More winners to choose from
a bubble. Bubbles are characterised by term investors like Rathbones, it makes A repeated question in recent years
the separation of asset prices from their sense to focus on those companies — which has been amplified by the
fundamental value. The outperformance that can benefit from their durable pandemic — is whether investors are at
of US equities — and particularly competitive advantages. greater risk of relative loss if they don’t
America’s technology giants — has been Research by investment bank pick the winners. This has tended to be
driven as much by their earnings growth Goldman Sachs suggests opportunities shorthand for that elite club of US tech
as by their valuation. Unlike the tech for investing in these future “innovators, giants. What the question boils down
stocks at the turn of the millennium, disruptors, enablers and adapters” can to for investors is whether the largest
these companies generate billions of be found across virtually all sectors, earners are increasing their share of total
dollars of earnings growth, even though including retail, healthcare and other earnings — or what we might call winner
they also spend billions on research and more traditional industries. takes all. Research we conducted in
development and other intangible items, With the world’s focus turning to 2019 showed that, while the share of the
which accounting rules don’t allow them a green transition, this could have the largest earners was indeed large, it hadn’t
to ‘capitalise’ (effectively spread out effect of amplifying innovation and changed much over the past 30 years. If
over a number of years) and instead get disruption in industries like energy, anything, that share had been decreasing
subtracted from earnings immediately. utilities, industrials and transportation. in more recent years.
Our research suggests that adjusting Companies already using technological While we’re not claiming to have
earnings and book value for what we call innovation to help drive the green found the winners of the next 10, 20
“knowledge capital” and “organizational transition can be found across a wide years or more, we believe there is good
capital” makes their valuation multiples spectrum of industries and geographies, reason to think there will be plenty of
look far less lofty. from small hidden gems to large opportunities across many and varied
Much of the difference in the established brands. sectors, and in lots of different places.
valuation of these American companies Goldman’s research suggests the That’s good news for active global
and more averagely valued ones in the split is fairly even across North America, investors like ourselves — as well as for
global index can also be explained by Europe and Asia. That compares with our clients.
interest rates. American tech companies’ a much greater US concentration of
earnings are expected to grow at a higher about 60% in the current makeup of
rate for longer than the average business. the MSCI World Index, for example
That means more of today’s price is (figure 3). Another case for having an
determined by future earnings, and so active investment approach, rather than
it’s more sensitive to the discount rate passively tracking an index.
used to translate tomorrow’s earnings
into today’s money. As interest rates have
fallen, American tech valuations have Figure 3: Geographical breakdown of headquarters location
risen. None of these things suggest a Research suggests tomorrow’s winners can be found across virtually all sectors, including retail,
separation of prices from reality. healthcare and other more traditional industries.
That said, as new technologies come
Innovators + disruptors + enablers + adaptors MSCI All Country World (market cap weighted)
to the fore we must ask, are all the geeks
American, and do they all work for the
US tech giants? Of course, the US tech Africa
Middle East
Latin America
1%
Africa
Middle East
Latin America
1%
sector is and will remain a big driver of 1% 1%
Asia Pacific
innovation and overall earnings growth, ex Japan
Asia Pacific 12%
but future investment opportunities ex Japan Japan North America Japan
25% 4%
could be spread more widely. 35% 7%
North America
Europe 63%
17%
A competitive advantage
Europe
As we explore in our lead article, 33%
investors have been wrestling with the
implications of post-pandemic reopening Source: Goldman Sachs.
in terms of inflation, monetary policy Past performance is not a reliable indicator of future performance.
InvestmentInsights | Issue 31 | First quarter 2022 rathbones.com 5Growth vs value?
The quality and visibility of
company profits are what matter
Global equity markets have been on an far more resilient as they benefited from forecasts have been the key determinant
upward path more or less since their a surge in investment in the computers of stock performance. This is not
precipitous drop in March 2020, when and remote hosting of cloud software surprising, as it is what tends to happen
the world first went into lockdown. applications that facilitated remote in the middle of an economic cycle, after
Over the course of this nearly two-year working. the initial spurt of growth at the start of
advance, leadership has passed from Following the November 2020 the recovery.
one investment style to another. But announcement of effective vaccines, The rebound in economic activity
rather than choosing broad styles like market leadership shifted to the sectors has been so robust that it has created
growth or value, we believe a more and stocks that had underperformed bottlenecks in the supply of various
company-specific focus on the quality through the initial pandemic crisis and economic inputs, from labour to
and durability of profits will continue to would benefit from a normalisation of commodities and freight services, which
be the best guide for finding long-term economic activity (figure 4). Companies since the second quarter of the year have
returns as the world moves on towards a that become known as ‘recovery’ stocks caused heightened inflation concerns for
post-COVID normality. were found in both traditional value business owners and policy makers alike.
The market’s recovery was initially areas (which typically trade at lower This has created a volatile and uncertain
driven by the swift reaction of Western valuations), such as energy and banks environment for profit margins and
governments to lockdowns, limiting the and so called ‘cyclical’ companies that corporate earnings, which has only been
potential for them to cause permanent are more geared to economic recovery, exacerbated by the emergence of the
structural increases in unemployment such as travel and leisure, which had Omicron variant.
and losses to economic productivity. suffered from COVID-related closures Further uncertainty surrounds the
The investment styles of ‘defensive and weakened demand. pace and timing of monetary tightening
growth’ and ‘quality’ initially led the as authorities respond to inflationary
recovery in 2020 as investors shifted Persistent performance pressures proving less transitory than
towards beneficiaries of COVID-driven The outperformance of these recovery had been initially expected. Rising short-
changes. They include consumer stocks persisted until February 2021 and term bond yields (figure 5) are typically
staples that were favourably exposed to the emergence of the Delta variant, when not conducive to segments of the
increased consumption as people spent concerns about the pace of recovery market with higher or more defensive
more time at home (such as packaged temporarily reasserted themselves. Since growth rates. As more of their price
food and dishwasher tablets) and March 2021, there has been relatively today is determined by future earnings
technology companies which facilitated little differentiation between value and (compared with the average company),
and benefited from an acceleration in growth investment styles, or between they are more sensitive to these short-
e-commerce and in remote working cyclicality and defensiveness. Earnings term yields, which provide the discount
and networking (defensive growth). momentum and revisions to earnings rate that is used to translate tomorrow’s
Companies with recurring and
predictable revenue streams (quality),
affording them earnings resilience, Figure 4: Global performance of cyclical relative to defensive sectors
were favoured over so-called cyclical Cyclical sectors have given back some of their earlier outperformance as style leadership has
companies whose demand was more shifted over the course of 2021.
sensitive to economic conditions.
The unique conditions of the 112
110
COVID downturn, in which lockdowns
108
restricted mobility and caused entire
106
purchasing channels such as restaurants
104
and high street stores to be shut down
102
for extended periods of time, led to
100
weakness in businesses reliant on 98
footfall, which would have held up much 96
better in more conventional downturns. 94
Rebased to 100 from January 2021
Conversely, some sectors that tend to be Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
cyclical in more ‘normal’ circumstances, Source: Refinitiv, Rathbones.
such as semiconductors, proved to be Past performance is not a reliable indicator of future performance.
6 rathbones.com InvestmentInsights | Issue 31 | First quarter 2022Growth vs value?
earnings into today’s money. Yet some of online gaming, online food delivery and likely continue to be driven less by any
the leaders in these sectors have thrived other aspects of online consumption), particular investment style than by
and indeed re-rated in what is turning growing automation and digitalisation of picking the stocks with the best earnings
out to be a productive environment for industry and increasing electrification of momentum — underpinned by structural
stock selection. energy systems and transport. growth drivers and a strong business
One example is software giant Electrification is part of a wider model that is resilient to inflation. As the
Microsoft, which reported 22% sales structural trend of investment in initial recovery comes off the boil and
growth in the third quarter of 2021 sustainability and transition towards a enters its next phase of normalisation,
driven in particular by Azure and cloud more renewable-energy-based system. a balanced approach seems warranted,
services as well as the ongoing rollout The ever-increasing importance of including exposure to companies in
of subscription services such as Office this transition to ‘net zero’ carbon both the growth and value camps (you
365 and Dynamics 365. Another is spirits emissions was evidenced by government can read more about our views on the
company Diageo, which was initially and corporate commitments economic outlook in our lead article on
hit by the COVID-driven closure of bars, around November’s COP26 climate page 3). Whatever the style, emphasising
but swiftly used its market leading data change conference in Glasgow. these company-specific qualities
analytics and agile business model to (You can read about the investment seems to us to be the best method for
pivot its marketing and distribution implications of COP26 in our post-COP generating future returns.
towards at-home drinking occasions. InvestmentUpdate* and about the global
Of course, this past outperformance economic impact in our article ‘Will the * www.rathbones.com/knowledge-and-insight/
investment-update-cop26-good-cop-or-bad-cop
may not be repeated as the recovery green transition help or hinder economic
moves into its next phase and beyond, expansion?’ on page 8.)
but it highlights the need to look to A key factor for success in 2021,
company specifics rather simply focus given the sharp rise of inflationary
on particular styles. pressures, has been inflation sensitivity
(how flexible companies can be in The low-hanging fruit of
Recovery from the lows finding lower cost inputs, and/or how recovery has been reaped
Many ‘COVID victims’ have enjoyed well they can pass on higher costs to and performance will likely
a recovery from depressed levels customers), which is generally a function continue to be driven less by
of profitability and share price, but of strong competitive advantage and
any particular investment
others such as travel-related stocks differentiation, high switching costs and
have continued to languish as full relatively sticky customer demand. style than by picking the
reopening and normalisation have been The low-hanging fruit of recovery stocks with the best earnings
delayed. The value sector of mining has has been reaped and performance will momentum.
also seen more muted performance
because of its reliance on demand for
iron ore from Chinese construction Figure 5: Short-term US Treasury yields are on the rise
and infrastructure development. After Rising short-term bond yields are not typically conducive to segments of the stock market with
surging in 2020, the curtailment of these higher or more defensive growth rates.
activities and the travails of the Chinese US 1-year Treasury yield (%)
property development sector have led 0.35
to a collapse in iron ore prices in recent 0.30
months.
0.25
Many of the stocks that enjoyed
outperformance in 2021 benefit from 0.20
structural tailwinds which have persisted 0.15
throughout the last two years almost 0.10
irrespective of COVID (and often 0.05
accelerated by it). These include the
0.00
increased penetration of cloud-based Jan 21 Feb 21 Mar 21 Apr 21 May 21 Jun 21 Jul 21 Aug 21 Sep 21 Oct 21 Nov 21 Dec 21
software and services, the inexorable rise Source: Refinitiv, Rathbones.
of e-commerce (along with digital media, Past performance is not a reliable indicator of future performance.
InvestmentInsights | Issue 31 | First quarter 2022 rathbones.com 7Net zero growth
Will the green transition help or
hinder economic expansion?
A key question for investors over the might find that the transition actually the benefits over time. Economies and
first half of this century, and one for boosts growth. Including the first businesses can evolve and adapt to well
which there is a lot of diverging opinion industrial revolution we have had five signalled and spread-out changes, but a
out there, is whether the move toward great waves of productivity growth: more sudden imposition of policy — for
‘net zero’ carbon emissions will help energy revolutions have been involved example in 2028 or 2029 — could entail
or hurt economic growth. Though the in four of them. So why can’t we have huge transition risks. And it isn’t just
recent COP26 global climate summit in another industrial revolution powered by about policymakers. We urge higher
Glasgow had its disappointments, we cheaper green energy? carbon businesses we speak with to
remain hopeful that governments and That’s the optimistic view. adopt robust decarbonisation policies
businesses will avoid a negative impact Economists at the Bank of England today, to decrease that risk of a more
from this transition by taking sufficient (BoE) and the Network for Greening the sudden, financially disruptive policy
action sooner rather than later. Financial System (NGFS) suggest the being imposed by governments further
A recent report from the International transition to net zero is likely to reduce down the line. Those same economists at
Energy Agency (IEA) concluded that GDP by 2050, but only by 1 percentage the BoE/NGFS expect GDP in 2050 to be
annual investment in the energy point. So only a little less growth than 5 percentage points lower if we delay the
industry will need to rise from $2 trillion if we do nothing. A recent review of transition by 10 years.
today to $5 trillion by 2030 if we are to the academic literature showed an You can hear more on the net-zero
transition to a net zero world. But you inconclusive split between studies that transition from our co-chief investment
can’t simply add that extra suggest it would help, hinder or make no officer Ed Smith, stewardship director
$3 trillion per year to annual GDP and difference to economic growth. Matt Crossman and Kate Elliot, head of
say ‘happy days, more growth’. ethical, sustainable and impact research
That would be to ignore the question Worth the cost at Rathbone Greenbank Investments
of where that $5 trillion dollars is coming Our base case is a small negative impact in this video* of our November COP26
from. Capital doesn’t grow on trees. on growth by 2050, but we are optimists. webinar. We’ll also be communicating
It’s most likely to come from capital Eliminating the huge negatives from not in greater depth on this crucial question
that otherwise would’ve been invested combating climate change, which don’t of economic impact over the coming
elsewhere. In which case, will this net- show up in GDP figures but do actually months — so stay tuned by visiting
zero transition lead to less innovation, impact our wellbeing, is probably worth rathbones.com or speaking to your
less productivity growth than if this that cost (figure 6). investment manager.
capital wasn’t diverted from elsewhere? Policymakers need to take action
That’s a really crucial question. now, however. That’s the best way to * www.rathbones.com/knowledge-and-insight/
cop26-what-investors-need-know
prevent the economic costs outweighing
An optimistic outlook
We are optimistic for a couple of reasons.
First, some of this investment is likely Figure 6: Expected average UK annual GDP growth (%)
to be in public infrastructure, which Early and orderly action to combat climate change would be expected to produce better future
encourages lots of job creation and growth than doing nothing or starting too late.
investment and raises productivity. The
Year 6–10 Year 11–15 Year 26–30
second reason is that the fall in the cost
1.8
of clean energy technology has exceeded
1.6
even the most optimistic expectations
1.4
from 10 to 20 years ago. There is some
1.2
interesting evidence that the change 1.0
in the cost of climate-change fighting 0.8
technology assumed by many of the 0.6
models used to determine the economic 0.4
impact is too slow. 0.2
If you assume the cost of these 0.0
No additional action Early and orderly Late and disorderly
technologies falls at a pace similar
to what we have seen in many other Source: Network for Greening the Financial System, Rathbones.
technologies in the last 50 years, you Past performance is not a reliable indicator of future performance.
8 rathbones.com InvestmentInsights | Issue 31 | First quarter 2022Paying down the debt
Beware the growing pile of gilts as
the UK’s credit card bill comes due
To pay for its economic response to Looking ahead to the 2022/23 fiscal The fall in gilt yields (meaning
the coronavirus pandemic, the UK year, Barclays estimates just under prices increased) that followed the
government borrowed more in the fiscal £73 billion of net gilt issuance. But this autumn Budget, when estimates for gilt
year 2020/21 than at any time since doesn’t take into consideration the supply for this fiscal year were lowered
records began in 1946. It’s not as though potential for the BoE to stop reinvesting significantly, shows that net supply
this episode has escaped the notice of the proceeds from its gilt holdings as can affect gilt prices. The potential for
bond investors — plenty has been written they mature, which its Monetary Policy that supply to increase significantly
about the increase in government Committee (MPC) has indicated will going into the next fiscal year is one of
borrowing during the health crisis. So happen when it has increased its base a number of factors that make us wary
you would be forgiven for wondering rate (its official lending rate) from 0.25% of having too much exposure to longer-
why UK government bonds (gilts) to 0.5%. Market-based rate expectations dated gilts, given their greater sensitivity
haven’t taken a hit. at the time of writing suggest this will than shorter-dated gilts to any rise in
A host of factors can influence the happen in May. That would result yields from their current low levels.
price of government bonds. However, all in another effective £9 billion of net As we approach 2023, we expect
else being equal, a large increase in the supply (from redemptions that are not a growing focus on the BoE’s plans to
supply of something would be expected reinvested). That would take us to net stop reinvesting the proceeds from gilt
to put downward pressure on its price supply (ex-QE) of around £82 billion, the redemptions as some larger holdings
(the same number of pounds spread out highest level for a number of years. within its QE programme reach maturity.
over an increased amount of gilts).
When analysing government Rate expectations
bonds, we look at net supply. This One of the reasons we disagreed with
figure is supply less redemptions on the market expectations for the base rate to
assumption that bondholders would reach 0.5% in February is because
reinvest the capital received from £25 billion of BoE gilt holdings are
those redemptions, thus absorbing maturing in March. According to the
an equivalent amount of new supply. MPC’s guidance, this would therefore be One of the reasons we
However, we also need to consider the added to the net supply of gilts rather disagreed with market
impact of quantitative easing (QE), or than be reinvested. Still, net supply for expectations for the base rate
gilts purchased by the BoE, which don’t the first three months of 2022, in other
to reach 0.5% in February is
have to be absorbed by the market words the last quarter of fiscal year 21/22,
(figure 7). will be negative and that means there because £25 billion of Bank
won’t be any supply pressure on gilts in of England gilt holdings are
Under pressure the near term. maturing in March.
Once we look at net supply excluding
QE (net supply less QE purchases
undertaken in the year, a more ‘true’ Figure 7: Bank of England gilt purchases (£ billions)
reflection of net supply in our view), the The central bank’s substantial quantitative easing programme has distorted the price of
lack of pressure on gilt prices from the government bonds and is likely to continue to exert its influence.
pickup in supply makes more sense. In
1000
total the BoE announced £450 billion of
additional QE in 2020 (£440 billion of
800
which related to gilts, the final £10 billion
relating to corporate bonds).
600
Not all of this was undertaken in
fiscal year 20/21, the final purchases were
being made in December. Excluding QE, 400
the net new supply of gilts looks far less
alarming. Net issuance of £388 billion 200
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
becomes just under £66 billion, while for
fiscal year 21/22 the net supply excluding Source: Bloomberg.
QE is expected to be just over £21 billion. Past performance is not a reliable indicator of future performance.
InvestmentInsights | Issue 31 | First quarter 2022 rathbones.com 9Financial markets
High inflation and uncertainty about
GDP growth Inflation
central bank policies raised concerns
% annual change % annual change
about the economic recovery. Rising 4 7
US
COVID infections and the new Omicron 2 6
variant were another cause for concern, 5
0
and social restrictions came back in eurozone
Japan
4
–2
December. However, leading economic 3
UK
US
indicators pointed to a continuation of –4
2
eurozone
strong growth as the world economy –6
1
enters the next phase of recovery from Japan
–8 0
the pandemic.
–10 –1
Despite ongoing concerns, global UK
equities performed well at the start of –12 –2
2017 2018 2019 2020 2021
the period and finished the year with 2011 2013 2015 2017 2019 2021
decent gains. In October, US stocks had a Source: Factset and Rathbones. Source: Factset and Rathbones.
record month, with the S&P 500 surging
by 6.9%, its biggest monthly gain for
2021. The FTSE 100 also rose to a near Sterling Equities
20-month high in October, recovering $
1.6
€
1.5 220
all losses since the pandemic began. MSCI World Total Return Index (in sterling)
FTSE All Share Total Return
However, at the end of November the 200
1.5 1.4
discovery of the new Omicron variant
US dollars 180
and what it could mean for the potential
1.4 1.3
return of lockdowns unsettled markets. 160
1.3 1.2 140
Central banks change course
US Federal Reserve (Fed) Chairman euros 120
1.2 1.1
Jerome Powell also spooked markets 100
when he said it was time to drop
October 2016 = 100
the word “transitory” from the Fed’s 1.1 1.0 80
2017 2018 2019 2020 2021 2017 2018 2019 2020 2021
statements on inflation, though markets
regained their poise into the end of Source: Factset and Rathbones. Source: Factset and Rathbones.
December. While the tone from the Fed
has changed, Powell still expects inflation Government bonds Gold
to fall closer to the central bank’s 2%
10–year yields (%) US dollars per troy ounce
target over the course of 2022. 4 2200
Government debt rallied over the
prospect of widespread COVID-19 3
2000
lockdowns as investors turned to assets
1800
traditionally seen as carrying lower 2
risk. Gold prices also rose as investors US
1600
looked for a safe haven amid increasing
1
uncertainty and high inflation. UK 1400
It was another rollercoaster quarter
0
for energy markets, with the price 1200
Germany
of Brent crude hitting $84 a barrel
–1 1000
in October before falling back down.
2017 2018 2019 2020 2021 2017 2018 2019 2020 2021
European natural gas prices also soared
Source: Factset and Rathbones. Source: Factset and Rathbones.
to fresh records due to worsening supply
from Russia, depleted reserves and high Past performance is not a reliable indicator of future performance.
demand from Asia.
10 rathbones.com InvestmentInsights | Issue 31 | First quarter 2022Important information
This document and the information within it does Management International Limited is not subject Not for distribution in the United States. Copyright
not constitute investment research or a research to the provisions of the UK Financial Services ©2022 Rathbones Group Plc. All rights reserved. No
recommendation. and Markets Act 2000 and the Financial Services part of this document may be reproduced in whole
The value of investments and the income Act 2012; and, investors entering into investment or in part without express prior permission.
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Past performance is not a reliable indicator of future performance.
InvestmentInsights | Issue 31 | First quarter 2022 rathbones.com 11Contacts
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