We hope you are keeping well amidst this latest cold snap. Forecasts suggest we may have to be a little patient before spring really kicks on – but then we know only too well of the fallibility of forecasts… across all domains!

Turning to investment and it’s not just the weather which has cooled. After a blistering start to the year, investment sentiment and investment performance fell back in February.

Investors will be all too familiar with the volatility associated with investing but fading momentum in February might be particularly disappointing given the improvements seen in economic data. But in the often-paradoxical world of financial markets, good news can often weigh on risk appetite, with investors fearing a more restrictive policy response.

First came the blow out US Jobs numbers early in February, signalling the US labour market remains in rude health. Such high levels of employment threaten a continuation in robust levels of consumption, serving to keep inflationary pressures elevated. Later in the month, stronger than anticipated US Retail Sales data and upside surprises to inflation prints, further fuelled anxiety over an economy in need of ‘cooling’. By the end of the month markets were broadly anticipating a peak in US interest rates of 5.5%, having moved up from roughly 5% at the start of the year. A ‘higher for longer’ interest rate environment raises the prospect of more troubling economic outcomes, informing the markets behaved rationally in February, and that investors should brace themselves for further volatility.

Despite this more worrying development, we are not hastily orienting investment strategy toward a starker defensive footing. Though the speed of price falls has disappointed, the trend remains in place. And with the potential for further progress in reopening supply chains, commodity price weakness, the general malaise within the housing market, and the lagged impact of prior rate rises, inflation weakness may yet become more pronounced. Moderating inflationary pressure could be met with a dovish turn from policy makers and reignite risk appetite in so doing.

Inflation may not fade at the desired pace, however, or central banks may choose to tackle it with continued vigour in the face of a resilient economy. Either scenario would likely be received poorly by markets given it feeds the ‘higher for longer’ interest rate narrative, which itself elevates the risk of recession. Though again we would argue all may not be lost for equity investors in such an environment. A recession that seems so widely predicted may not inflict the same damage as one that catches investors off-guard. The recession may not be so severe either, given the apparent absence of major economic imbalances i.e., banks, corporations and households don’t (in aggregate) appear to be shouldering quite so much leverage as in past, more devastating recessions.

We should also remind ourselves that having moved off the zero bound, there are now interest rates to cut! Again, this policy flexibility might prevent a more pernicious downturn and prove sufficient to reignite economic and investor enthusiasm.

Timing a defensive pivot to then time the recovery is a risky game, and one we are reluctant to play; preferring instead to take a more measured approach which incorporates longer term thinking.

Kind regards,

iPensions Wealth Team

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