Fixed Interest

February was a wild ride for fixed income markets as yields rose dramatically through mid-month, in many instances to post-pandemic highs, before falling precipitously on fallout fears from the conflict in Ukraine. Inflation and economic activity data in the West generally supported higher yields but current data has been overwhelmed by the potential impact of the conflict on both inflation and economic growth. Therefore, some investors fled to perceived safety in the normal fashion.

Even before the invasion, there had been some investor debate as to whether central banks had switched from being too complacent about inflation to potentially being overzealous. We think this potential zeal has been tempered by events in the Ukraine with the US being the most likely exception.

More clarity about the end game will be required before markets calm down, but when it emerges there is ample scope for bond yields to rise back up again. One of the most likely outcomes of the conflict is increased defence spending across Europe and this could add to long term pressure on yields. As we would expect in such tumultuous times, corporate and high yield bonds fell too, so no bond market escaped unscathed. Local currency emerging market debt held up best over the period.

 

The UK

A virtually unchanged large cap index masked what was another very difficult month for UK equities as mid cap, small cap and, more generally, non-resource stocks, were buffeted by each of the imminent tightening of monetary policy, an upcoming squeeze on real incomes and, latterly, the conflict in Ukraine. Resource stocks, particularly oils, were the most sought-after equities and defensive stocks, unsurprisingly, made a strong relative comeback on the back of mounting uncertainty.

Away from the conflict, economic activity was on the whole encouraging, but rate fears were further fuelled by inflation hitting a forty-year high. Retail Sales and the Purchasing Managers Index are two examples of encouraging activity releases. The Ukrainian conflict has significantly increased the uncertainty around the trajectory of inflation, interest rate increases and business confidence, so we will stay close to events and assess opportunities as they arise. With many positive economic factors and the worst of COVID behind us, we are still positive on the medium term prospects for UK equities.

 

United States
For the first three weeks of February, value continued its year-to-date resurgence versus growth after the biggest year-on-year gain in CPI inflation for 40 years. Geopolitics soon superseded inflation in the headlines as Russia commenced its invasion of Ukraine, reversing the trends seen earlier in the month. Leadership turned towards defensive names at the end of the month and technology rebounded as bond yields fell.

At the index level, markets responded to the crisis in Ukraine by declining as sanctions were imposed on Russian companies, individuals and financial institutions. The wider market ended down just less than 3%, with other indices down more, despite a brief period of respite in the final days of the month.  

As things stand, the US should remain well insulated to events in Eastern Europe. Energy independence and little direct Russian exposure means that the US market could well act as a haven should the conflict escalate further.

 

Emerging Markets
Asian equities offered relief from the trauma encountered in the West. Hong Kong and India were the exceptions, as technology regulation roiled the former and vulnerability to higher oil prices impacted the latter. Chinese domestic shares fared better due to further policy easing and Korean, Thai, Vietnamese, Philippine, Indonesian, Malaysian and Singaporean shares also rose.

Chinese authorities have signalled they will continue to ease and economic numbers there are showing tentative signs of recovery. We are optimistic on Asian equities this year on the assumption that Sino Taiwanese relations remain under control. Our optimism is based on the fact Asia is closer to the end of a tightening cycle than the West and has more reopening pent-up demand.

 

Alternatives
Volatility remained elevated during the month, with the VIX breaking back above 30 in the latter stages, as events unfolded in Ukraine. In aggregate, the absolute return sector failed to meaningfully take advantage of this, with a broad basket of funds showing negative returns in February. Gold however continued to play its role as crisis protection in portfolios, with the precious metal gaining over 6%, amid a flight to defensive assets.

Commodity prices continued to march higher also, with crude oil breaking through the round number resistance of $100 per barrel for the first time since 2014. Russia remains a key exporter in the market and the developments in Ukraine will undoubtedly disrupt supply. The US is considering another release of strategic reserves to ease the upward pressure on price. However, it is notable that this had little impact when executed at the back end of last year. 

 

Property
The UK property market continued to run hot last month as several data releases showed strength continued into the New Year. House prices once again moved to a record high in January, although there were some early indications that the pace of growth may be beginning to slow. The removal of government support and the cost-of-living squeeze in the UK could be catalysts for a slower market later in the year, following two years of rapid house price growth where over £40,000 has been added to the average UK home price.