This April, stock markets recorded their biggest monthly drop since March 2020, even though companies reported better-than-expected Q1 2022 earnings. This indicates that, akin to what we saw during the first part of the year, markets are being influenced primarily by macroeconomic factors, and only to a lesser extent by company fundamentals.
Bond markets likewise were subject to further losses in April, in both the sovereign and corporate segments. The Bloomberg Global Aggregate index (the main global benchmark for investment-grade investors) fell 5.48% in April and is down 11.30% since the start of the year – its worst correction since 1980.
Inflation is clearly leaving its mark.
It showed no signs of easing in April despite the slowdown in economic output. US consumer prices jumped 8.5% year-on-year in a particularly tight job market environment, yet the country’s GDP shrank by 1.4% in Q1 – its first quarterly contraction in nearly two years.
Inflation is also elevated in Europe, but that’s more a reflection of the soaring commodities prices. These lofty prices have caused the cost of living to skyrocket and are eroding companies’ profit margins. Emmanuel Macron’s re-election as French president is reassuring for investors when it comes to the EU’s fiscal intentions, and it increases the likelihood of group sanctions against Russia – all of which confirms the stagflationary nature (i.e. stagnant economic growth combined with high inflation) of the economic shock hitting Europe.
Central banks in both the US and the eurozone are concerned about the upswing in inflation expectations and have stressed their desire to keep consumer-price appreciation under control, regardless of the effects on GDP growth. This hawkish stance has quickly pushed up the yields on 10-year Treasuries and Bunds, which jumped 60 bp and 36 bp, respectively, and are now flirting with the psychological levels of 3% and 1%. These higher yields have dragged down the prices of risk assets as well as conventional safe-haven assets.
Meanwhile in China, the government is still pursuing its strict zero-Covid policy – complete with severe lockdowns – in response to a bump in new infections. This forced slowdown of the economy is worrying because it is disrupting supply chains and denting China’s GDP growth prospects, especially since Beijing apparently wants to wait until the pandemic improves enough before taking steps to engineer a strong economic rebound.
At this point, we believe it’s wise to keep a low allocation to equities, which now make up around 15% of our Carmignac Patrimoine portfolio. We have positioned our underlying equity portfolio for a market landscape in which company fundamentals are once again the determining factor in performance drivers. Our equity holdings are concentrated in companies that stand to come out of this period of cost pressure and slower GDP growth either unblemished or even stronger.
We are invested in defensive businesses in essential industries like healthcare and consumer staples, in quality businesses with low debt levels and high profit margins, in businesses involved in the energy transition and that meet our ESG criteria (like Schlumberger, which has formed new partnerships to manufacture and distribute technology for the development of next-generation energy systems), and in businesses in the travel industry (Ryanair and Airbus) now that most international travel restrictions have been lifted.
Credit spreads widened further in April as corporate bonds were once again battered by central banks’ moves to normalize monetary policy at a time of decelerating economic output. We scaled back our allocation to this asset class and shored up our hedges by purchasing CDSs on indices. Now our investments relate mainly to select issuers in industries like energy and finance, which are expected to benefit from high commodities prices and interest rates. Our structured credit holdings – variable-rate debt instruments backed by premium-quality loans – are also attractive in the current climate. They provide a cushion against higher interest rates but also higher default rates, along with attractive yields.
The stretched commodities prices are of good omen for producing countries in emerging markets, particularly in Latin America. These countries are also well advanced along their monetary-tightening cycle. We hold positions in local-currency Brazilian debt and in the Chilean and Mexican pesos. Debt from Eastern European countries has come under pressure recently due to the countries’ location and is now very attractive. For example, the yields on local-currency Hungarian bonds are close to 6%, after climbing by 4.75% in only the past four months.
We are still actively managing our interest-rate risk in both Europe and the US. We adjusted our positioning on short-dated maturities, since they already factor in particularly swift and significant monetary-policy normalization. We also modified our positioning on the long-dated end of the curve, as we don’t believe these maturities have fully priced in the lasting nature of inflation and the effects of the Fed’s winding down of its balance sheet. Our positioning on US Treasuries may appear broadly neutral, but it’s actually poised for a steepening of the yield curve.
Overall, we intend to manage risk actively in response to the pick-up in volatility, in order to preserve our long-term investment opportunities.
Sources : Carmignac, Bloomberg, 04/05/2022
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EQUITY: The Fund may be affected by stock price variations, the scale of which is dependent on external factors, stock trading volumes or market capitalization.
INTEREST RATE: Interest rate risk results in a decline in the net asset value in the event of changes in interest rates.
CREDIT: Credit risk is the risk that the issuer may default.
CURRENCY: Currency risk is linked to exposure to a currency other than the Fund’s valuation currency, either through direct investment or the use of forward financial instruments.
The Fund presents a risk of loss of capital.