Any hopes, ours included, that the US inflation numbers released in the middle of September would show a moderation of this key variable were not well founded. Falls in areas such as consumer durables, transportation and energy, were more than offset by other areas such as rent, wages and healthcare.
In aggregate, US core inflation, which excludes volatile energy and food prices, increased from 5.9% the previous month to 6.3%. On seeing this, equity and bond markets duly repriced downwards.
This continued inflation problem will embolden central banks to continue to raise interest rates, likely faster and to a higher level than was thought even a few weeks ago. The expected high point for interest rates in the US and UK has moved from 3-4% to 4-5%, with the commensurate impact on the value of equity and debt markets.
Adding to this is a sense that the global economy will not be able to withstand this level of interest rates without going into a recession. Indeed, it could be argued that a recession will be the price of bringing inflation back down. Rising interest rates and falling economic activity is a pincer movement for asset prices, and unusual given that interest rates are usually falling at times of economic weakness. Consequently, there is no shortage of bearish commentary on investment markets.
Lessons from bear markets
Bear markets are part of investing. Historically, equity markets rise in around 7 out of 10 years: in the other three, a recession or a shock such as Brexit usually dominates. We are undoubtedly in a bear market today. Depending on the market in question, it started around the turn of the year, which makes it nearly nine months in length, with key markets such as the US S&P 500 and Nasdaq down 20-30%. This is an average bear market up until now, both in time and scale. Of course, there are bear markets which have lasted longer than this with larger falls. The bear market of 2007-09, which coincided with the Global Financial Crisis (GFC) of those years, lasted 17 months and the S&P 500 fell 50%.
I managed the sustainable funds through this period, and it was a uniquely unpleasant experience. It tested the resilience of investors to the core and some did not come through it. This is a great shame, as what followed was a 12-year bull market of size and scale that enriched many people’s lives. Here are some of the things I learnt:
- The key challenge of operating in bear markets is psychological. News tends to be relentlessly negative and gets worse as the bear market progresses. This cumulative effect is corrosive and often leads to bad decision-making.
- Even the worst bear markets end. Over time, economies grow, and corporate profits benefit from that. Bear markets are the exception, not the rule.
- The ending of a bear market requires resolution of the core issues creating it. For the GFC it was when governments stepped in to shore up the banking system, where the crisis had started, which eventually turned the economy and markets around. This bear market started with inflation, and it will end with inflation being brought under control.
- The beginning and end of bear markets is only obvious in hindsight. It is hard to get the timing right because they usually start and end with a largely unforecasted event.
- For truly long-term investors, bear markets allow the accumulation of investments at more favourable prices (as the saying goes, you pay a high price for a happy consensus, conversely a low price for a miserable one). They must be endured to deliver a successful long-term outcome.
None of these points suggest that we, or indeed anyone else, knows where markets will move in the next few months. No one has privileged access to the future. They are though points which, after this bear market is long gone and we look back at it as we do now with the GFC, will make a lot of sense.
With a range which covers single and mixed-asset funds, as well as UK and global markets, we see all the market trends. Here are some comments:
UK equity funds
The UK market, the FTSE All-Share, is a commodity- and value-orientated market. It has been a serial underperformer relative to global indices for this reason. This year it is having a better time, with those characteristics, contrary to the previous decade, being in high demand. This has wrongfooted most UK managers as, despite it being a poor index, it is a good market with many world-leading growth companies. These companies have allowed many active UK managers, us included, to bridge the gap between the returns available from the UK market to those available more globally. This source of alpha (performance) has gone into reverse this year, with the better (as measured by return on capital and growth potential) the company, the worse its share price performance and vice versa. Our sustainable funds invest in high quality, socially and environmentally relevant businesses which we believe, over time, will become much more profitable. This has certainly not been in vogue. Despite this, and with no exposure to commodities, we have not materially underperformed the peer group due to us having no exposure to more speculative parts of the FTSE 250, which have caused wider problems.
The performance of the equity elements of our mixed asset funds is largely as we would have expected, given the macro environment and our preference for higher quality, growing businesses. What was not expected was the performance of sterling credit, which has fallen as far as our equity exposure. This has been almost entirely driven by the rise in UK government bond yields (causing prices to fall), which credit is priced off. This has meant two things. Drawdown in the mixed-asset funds has been greater than in the past as bonds have not acted countercyclically to equities; they have both gone down together. It has also meant that the funds rated as lower risk on services such as Defaqto have done worse than the higher risk ones into a rising risk environment. This inverse nature of markets is unique in the time we have been managing the mixed asset funds. In our view however, the underlying investments in these funds remain strong, and should benefit from any improvement in overall markets, as they did during the summer.
Our Global Sustainable Equity Fund was launched in February 2020, just as the pandemic hit. When it gets to its three-year anniversary in February next year it will have seen a variety of market conditions that some funds wait decades to see. It is the most growth-oriented of our funds, due both to the greater emphasis on growth within its benchmark, the MSCI ACWI, and the numerous environmental and social opportunities we see to grow investor capital in the long term, while also improving society. It too has been influenced by market and macro trends this year. However, it is not invested in some of the more speculative parts of the technology area, so it has avoided some of the more problematic investments. We look forward to sharing the three-year numbers for this fund in the first quarter of 2023.
For Professional Clients only, not suitable for Retail Clients. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.
The Royal London Global Sustainable Equity Fund is a sub-fund of Royal London Equity Funds ICVC, an open-ended investment company with variable capital with segregated liability between sub-funds, incorporated in England and Wales under registered number IC000807. The Authorised Corporate Director (ACD) is Royal London Unit Trust Managers Limited, authorised and regulated by the Financial Conduct Authority, with firm reference number 144037.
For more information on the trusts or funds, or the risks of investing, please refer to the Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page on our website.