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Caerus Select Commentary - May 2022

Date: 29 June 2022

Market review

In May, there were signs of a shift in investor focus, away from worries about inflation and the rising interest rates needed to combat it and toward the weaker outlook for economic growth. This helped ease expectations of coming interest-rate rises and led to a pause in the sustained equity and bond market sell-offs we’ve so far seen in 2022.

Among equity markets, UK large cap stocks were again strong performers. The energy sector led the way, as oil prices rose, despite a 25% windfall tax on oil and gas company profits announced by the UK government, which subsequently impacted shares in energy generators such as Drax and Centrica.

Despite relatively strong performance by the UK’s largest stocks, the average fund in the Investment Association (IA) UK All Companies sector returned 0.5% in May, meaning it lagged the average return seen from the IA Europe ex UK, IA Japan and IA China sectors, but was still some way ahead of the small loss suffered by the average IA North America sector fund.

The higher-risk portfolios enjoyed modest gains thanks to their higher equity exposure

The average fund in the IA Japan sector gained 0.9% in May, thanks partly to a recovery in the yen after two months of heavy losses.

Although emerging market equities were helped by the easing of pandemic restrictions in China, the average fund return from the IA Global Emerging Markets sector was zero in May. China has continued to pursue a ‘zero covid’ strategy this year resulting in much of Shanghai being placed in lockdown. News that these restrictions were easing helped the average fund in the IA China/Greater China Index to gain 1.9% in May.

At its May meeting, the US Federal Reserve (Fed) confirmed that in June it will begin to sell the assets it purchased under its pandemic-era quantitative easing (QE) programme, meaning that quantitative tightening (QT) will get underway. It also raised its policy rate by 0.5%, double the usual 0.25% increment.

April’s consumer price index report (released in May) showed tentative signs that US inflation may be peaking with the headline rate dipping from 8.5% to 8.3%.

Signs that inflation may be peaking, and that the subsequent rate of interest-rate increases might slow, helped US Treasury yields to fall (meaning their prices rose), while global equity markets regained their poise and rallied in the last weeks of the month to be only marginally down in May.

The Bank of England (BoE) raised UK interest rates by another 0.25%, at its May meeting, to 1%. Having been among the first of the developed market central banks to increase interest rates, the BoE has so far been unwilling to ramp up the pace of tightening, despite increasingly rampant inflation, due to a particularly weak growth outlook. Monthly UK GDP growth for March was down 0.1%.

Over the month, the average fund in the IA UK Gilts sector declined 2.4% in the face of rising UK interest rates while corporate bonds (issued by companies) generally delivered muted losses, with the exception of some regional pockets.

(All performance figures in sterling terms and rounded to one decimal point, unless otherwise stated.)

Performance review

The Caerus Select Managed Portfolios at the lower end of the risk range delivered small losses in May due to the decline in our fixed-income holdings. As fixed-income weightings are higher here, the positive returns from our equity holdings were insufficient to entirely offset such losses.

Meanwhile, those portfolios at the higher end of the risk scale, where equity weightings are greater compared to fixed-income, made worthwhile gains.

The developed market equity component of the portfolio was ahead of its benchmark index with the vast majority of underlying holdings positive in May. In particular, the Quilter Investors Europe (ex UK) Equity Income Fund (Schroders) outperformed on the back of an overweight to the energy sector and some smart consumer staples stock picks.

Within this, the UK equity element of the portfolios outperformed its benchmark index. UK equities had another decent month as large cap names led the way. The Artemis UK Special Situations Fund was well ahead of the market with a return of 4.2% in May, driven by its industrial stock holdings. This reversed some of its performance struggles from earlier in the year.

The lower-risk portfolios suffered muted losses due to their fixed-income exposure

Meanwhile, the Quilter Investors UK Equity, the Jupiter UK Equity Income and the Artemis Income funds also outperformed the UK index. The only UK laggard in May was the Blackrock UK Fund, which declined 1.6% as growth stocks came under renewed pressure.

Elsewhere, the M&G Japan Fund also had a good month; it gained 2.5%, thanks mainly to its industrials exposure. All of our Asian equity holdings were positive performers in May with each outperforming their regional benchmarks.

The performance of the BNY Mellon US Equity Income Fund also stood out due to its overweight to financials, which outperformed.

It remained a tough environment for ‘growth’ names; both the Allianz Continental European and the Quilter Investors US Equity Growth (JP Morgan) funds underperformed their benchmarks. Meanwhile, the BlackRock Gold & General Fund was again held back by weaker gold and silver prices.

The emerging market equity component underperformed its benchmark index. Despite strong performance from the

Janus Henderson China Opportunities, driven by the easing of lockdowns, and the Quilter Investors Emerging Markets Equity Income Fund (Allspring), which made a solid gain of 1.2%, a poor month from the Jupiter Global Emerging Markets Focus Fund wiped out these gains.

Meanwhile, the alternatives basket made solid ground in May. All holdings here delivered positive returns, with the exception of the Janus Henderson Absolute Return Bond Fund.

The Jupiter Global Equity Absolute Return (GEAR), Allianz Fixed Income Macro and PIMCO Dynamic Multi Asset funds all posted returns of more than 1%, while the PIMCO Dynamic Bond Fund delivered a more modest positive return.

The fixed-income basket in each portfolio was weaker with all holdings making a loss. The most pronounced losses were by the iShares UK Gilts All Stocks Index ETF and the TwentyFour Dynamic Bond funds, as bond yields continued to rise (meaning their prices fell) amid high inflation and rising interest rates.

Outlook

Looking ahead, while a more peaceful month for equity markets has been appreciated, it doesn’t constitute an end to the issues that have been haunting equity and bond markets so far this year, namely record levels of inflation, the aggressive interest-rate increases required to tame it and the ongoing war in Ukraine, which is pushing up energy and commodity prices, adding to the ‘cost of living crisis’ we’re now living through.

As we’ve already seen with certain corporate earnings guidance, there is now pressure on company margins thanks to rising input costs and wage bills. At the same time, the cost of living crisis shows no sign of abating and this will quickly whittle away at consumer confidence.

Finally, the unceasing level of financial commentary around the potential for a slowdown in economic growth, higher interest rates, the return of inflation, ‘stagflation’ (a combination of stagnant growth and inflation) and, ultimately, recession is only likely to further erode consumer confidence and nudge us a little faster along that path.

Meanwhile, we are sitting tight; we await an opportunity to pick up assets when the consensus view of equities is similar to that of global bonds today, namely that they’re virtually ‘un-investible’.

All our alternative holdings delivered positive returns in May

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Stuart Clark

Portfolio Manager

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