Commentary by QLO Advisors Ltd – A Thornbridge Appointed Representative
March provided some relief for equity investors with MSCI world returning +2.5%. Global bonds on the other hand lost another -3%. Bonds are experiencing one of the largest draw-down periods in 40 years. Consequently, most balanced investors continued to lose money in March and are down meaningfully this year with both equities and bonds losing around -6%. We are pleased to report that Wavebreaker again provided significant diversification and returned +2.5% in March and stands at +3.6% YTD, net after all fees (Class EUR F). The positive result was mainly driven by long commodity exposure and bets on higher interest rates. The inflationary pressure continued to worsen in March and central banks subsequently signalled further tightening of monetary policy. The war in Ukraine has added another round of base inflationary pressure and there is potentially significant upside to commodity prices depending on geopolitical events. In particular, we still believe that the impact on food prices is not sufficiently priced. Medium-term there are indications that inflation is becoming entrenched in both the US and the UK, and against this backdrop, central banks will likely hike interest rates to the point of demand destruction in order to prevent structural inflation pressure from rising further. So why are equities still holding up pretty well with inflation booming? The same very strong consumer demand which has driven inflation higher continues to provide significant tailwind to the global economy and thus sales and earnings. Restocking of goods from depleted inventories means that business sales has been significantly outpacing GDP growth, at least until now. Further supply chain issues have probably helped to drive desired inventory levels higher than usual for precautionary reasons. This is unlikely to continue much longer. Consumer demand is being hollowed out by inflation and inventories are back to normal (except for autos). Demand for goods is further at risk from a post-pandemic shift back to services. Business sales are thus set to slow noticeably in the next few months. Combined with significant wage/cost pressure and rapidly rising interest rates, and we have a potentially toxic cocktail for equities. It is not yet clear to us if we will hit a technical recession this year, but it is a close call by now. The size of the savings buffer from COVID is significant and could cushion the blow. However, the important thing for now is that the pace of growth is rapidly decelerating, excess savings or not. We also believe that cyclical inflation will likely peak in early Q2 and even if it remains elevated, this may provide some relief for bonds. A further rise in interest rates pose a significant headwind to equities and the pace of the increases are alarming, as rapid interest rate increases have at times triggered substantial downside corrections in equity markets, even outside of recessions. After adding some equity exposure pre and post the Ukraine invasion we have again started to cut back in response to these cyclical and market developments and are likewise slowly scaling back our short bond exposure as well. Over the coming years we expect the investment landscape to remain driven by the heightened inflation concerns and faster business cycles; this to an extent we have not experienced in many years.