Quarterly Review Summer 2021 Issue No. 85 INVESTMENT RISK Investing in ordinary shares and other assets that will be included in your investment portfolio entails risks to your capital and the income that it might generate. The paragraph below is an important reminder, please always remember that: The value of investments and the income you get from them may fall as well as rise and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance. The second half of this Review, from page 16 onwards, gives information on the Church House fund portfolios that we manage for our clients. Some, or all, of these funds feature in most portfolios and the risk warning above is pertinent to each of them as well as to investment portfolios generally. It is crucial to our approach to the management of risk to utilise these Church House funds to construct portfolios; each has a specific ‘building block’ role. This approach ensures a proper diversification and that we know in detail the risks that we are undertaking on your behalf - not something that we are happy to delegate to others. These funds are individually authorised by the Financial Conduct Authority under the Collective Investment Schemes regulations, with which we must comply at all times. We are required to point out that: 1. the main risks faced by the funds arise from market price and interest rate risk; 2. they have no borrowings, or unlisted securities of a material nature (so there is little exposure to liquidity or cash-flow risk) and, 3. we review the policies for managing these risks on a regular basis. Please get in touch with any questions about your portfolio, this report, or any change in your circumstances that you feel we should know about or could assist you with. Stewardship Little has changed under this heading. We have implemented the new UK Stewardship Code 2020, which incorporates Environmental, Social and Governance (ESG) matters, but have yet to hear back from The Financial Reporting Council as to whether we have satisfied their conditions to be on the first list of Stewardship Code ‘signatories’. 2 2 Quarterly Review Issue no. 85 - Summer 2021 CONTENTS THE ECONOMIC & MARKET BACKGROUND 5 THE UK ECONOMY AND INTEREST RATES 6 CREDIT MARKET COMMENTARY – JEREMY WHARTON 8 UK EQUITY MARKETS 10 INTERNATIONAL EQUITY MARKETS 12 FOREIGN EXCHANGE 14 COMMODITIES 14 CHURCH HOUSE INVESTMENT GRADE FIXED INTEREST 16 CHURCH HOUSE UK EQUITY GROWTH 20 CHURCH HOUSE BALANCED EQUITY INCOME 24 CH UK SMALLER COMPANIES 28 CH ESK GLOBAL EQUITY 30 CH TENAX ABSOLUTE RETURN STRATEGIES 34 DONALD RUMSFELD 36 Church House Investment Management Church House Investments Limited is authorised and regulated by: The Financial Conduct Authority 3 3 High inflation figures led to uncertain times in the fixed interest markets. I have marked the reaction to the 12th May release of 5% inflation in America, but, despite this, Gilt prices recovered (prices up in this market = interest rates down): UK Ten-Year Gilt – 31st March to 30th June Source: Bloomberg Meanwhile, the price of oil started to pick-up again, having rather stalled over the previous three months, adding to the inflationary concerns: Oil Source: Bloomberg 4 4 THE ECONOMIC & MARKET BACKGROUND After a good run, the enthusiasm of the market appears to be fading somewhat as we end the second quarter of 2021. Economic recovery is on track, but we face a tricky inflation conundrum and, of course, concerns over the latest virus variant as we ‘open up’ again. We have seen some uncomfortably high readings for inflation on both sides of the Atlantic, and this looks likely to persist for a few months yet. A jump in the reported numbers was inevitable as we work through comparisons with 2020 when practically everything stopped. The Bank of England, in common with the other major Central Banks, are explaining in soothing tones that this is a temporary blip in inflation and that it will subside again shortly. This is probably right but it will need to be seen to be right quite soon. Some aspects of inflation feel rather more persistent than transitory, which could easily start to impact inflation expectations, and so on to wage expectations. It could get tricky for the Central banks to justify rock-bottom interest rates if this happens. The other part of the conundrum is the level of longer-term interest rates in relation to inflation. Interest rates have actually fallen over the past few months (bond prices have gone up), such that the interest rate available on a Government ‘Gilt-Edged’ bond maturing in fifty years is currently 1%. This looks odd, certainly in relation to current inflation, but also in relation to the Bank of England’s long-term target of 2% annual inflation. As was observed recently: “If the two strongest month/month inflation prints in forty years didn’t upset bond markets, what will?” I think it is worth putting this into straightforward figures. Investing, say, £100,000 today in that fifty-year Government Gilt and assuming the Bank realises its inflation target, that investment will be worth a little over £60,000 in 2071 (in today’s money). I’m not sure that future generations would be that impressed. Put another way, the UK average house price today is around £250,000, are we really expecting it to be £151,000 in fifty years? That is enough soothsaying for now. Suffice to say that this represents an uncomfortable backdrop with potential for a sharp correction in the pricing of these assets, as the Bank of England recognises in its recent Financial Policy Report. Our portfolios have had a solid six months, good companies are returning to dividend payments and are in optimistic mood. As ever, we will continue to focus on the value, prospects and quality of the individual investments that make up these portfolios. James Mahon July 2021 5 5 THE UK ECONOMY AND INTEREST RATES Our economy continues to recover with overall activity up to around 92% of pre- COVID levels, which accords roughly with comments from Andrew Bailey, the Governor of the Bank of England, in a recent speech that: “The good news is that the economy is only around 5% smaller than it was eighteen months ago”. The latest minutes of the Bank’s Monetary Policy Committee (MPC) noted that growth has been stronger than they expected: “Since May, developments in global GDP growth have been somewhat stronger than anticipated, particularly in advanced economies” and “Bank staff have revised up their expectations for the level of UK GDP in 2021 Q2 by around 1½% since the May Report”. It is interesting to look at Jefferies’ ‘EAR’ reports (the source of our 92% figure above) to see the make-up of this recovery. At the extremes, flight activity (aeroplanes!) has improved slightly to 26% of pre-COVID levels (transport overall is running at about 80%), while visits to property web sites are running at 165% of normal (ending of that Stamp Duty holiday?). Visits to grocery web sites are running at around 140% (they had been up at 200%). Encouragingly, hiring and the listing of job vacancies continues to grow. It will be fascinating to see what impact the next round of lifting of social restrictions has on these numbers. The concern that is exercising economists everywhere at the moment is whether the strength of the recovery at a time of ultra-low interest rates and ‘easy money’ will lead to a resurgence in inflation. While we have all been expecting an increase as the comparisons to last year work through the system, the scale is causing some consternation, as can readily be seen on this long-term chart of US Inflation: US Inflation - CPI Measure - 1990 to 2021 Source: Bloomberg 6 6 The inflation picture for the UK is similar though it has not ‘spiked’ quite so dramatically at this stage. We have just seen a further move up in June, taking the annual rate of (CPI) inflation to 2.5%, the previous RPI measure is running at 3.9%. As with the US Federal Reserve and the European Central Bank, the MPC considers this to be transitory: “the Committee’s central expectation is that the economy will experience a temporary period of strong GDP growth and above-target CPI inflation, after which growth and inflation will fall back.” ... “In judging the appropriate stance of monetary policy, the Committee will, consistent with its policy guidance and as always, focus on the medium-term prospects for inflation, including the balance between demand and supply, and medium-term inflation expectations, rather than factors that are likely to be transient.” So we must expect no change for the base rate, which the MPC has held at 0.1% for fifteen months now. For longer periods, market interest rates have edged back down again: UK Interest Rates – The ‘Yield Curve’ (Base Rate and the income yield from Gilts) Source: Church House, Bloomberg Short-term: Base Rate 0.1% 3-mnth LIBOR 0.1% SONIA* 0.0%. Longer-term: Gilt maturing in: 2 years 5 yrs 10 yrs 20 yrs 30 yrs 50 yrs Yield** 0.1% 0.3% 0.7% 1.2% 1.2% 1.2% Source: Bloomberg *Sterling overnight index average. **The yield to maturity, taking into account interest received and price paid. 7 7 CREDIT MARKET COMMENTARY – JEREMY WHARTON President Biden remains busy, although not necessarily in a frantic rush to reverse some of the protectionist measures put in place by his predecessor (now in deep trouble with US investigators).