Russia’s invasion of Ukraine is exacerbating economic trends that were already established: rising inflation and slower growth. Although not our central hypothesis, the possibility of stagflation or even recession has clearly increased. The tightrope on which central banks are treading as they battle to contain soaring inflation without tipping economies into recession has narrowed and the risk of policy error remains elevated.
It was a painful quarter for investors in bond markets as spiralling inflation caused yields to rise significantly and prices to fall. Government bond yields are still very negative in real terms (i.e. after inflation) and could remain so for years to come. However, with economic growth set to slow markedly, the outlook for bond markets is more balanced. Our expectations of returns from investments in bond markets continue to be modest. As before and where our mandates allow, we favour flexible bond funds which can cherry-pick the best opportunities as they arise.
The first quarter of 2022 was characterised by one of the most violent swings in the fortunes of ‘Growth’ and ‘Value’ stocks ever seen, making it a much more difficult period for most investors than the relatively small declines in many stock markets would suggest. We believe that we hold a prudent level of equity risk in the portfolios we manage given the backdrop of slowing economic growth and rising interest rates. However, we are watching closely for any signals of impending recession and will not hesitate to reduce exposure to equities if the economic outlook deteriorates.