How we are navigating choppy waters

Saltydog Investor explains how they are positioning themselves following the FTSE 100’s high, and other markets’ lows.

 
Last week, most of the world’s major stock markets fell and some are now lower than they were at the beginning of the month.
 

^{Data source: Morningstar}

 
Although the year started well, there are still plenty of issues that could rock the boat. The war in Ukraine continues, global growth is weak, inflation is high, and interest rates are still rising. However, that is nothing new and is probably already factored into equity prices.

What is more encouraging is that growth is probably not as weak as some had forecasted (the UK narrowly avoided a recession in 2022), and inflation is falling (albeit slowly and it has got a long way to go). Earlier this month, it was announced that UK inflation had dropped to 10.1% in January, down from 10.5% in December, briefly pushing the FTSE 100 above 8,000 for the first time ever. In the US, annual inflation has fallen from more than 9% last summer to 6.4% at the end of January.

The problem is that at the moment economies around the world are on a knife edge. Governments and central banks are trying to encourage growth and avoid a recession, while bringing down inflation and limiting interest rate rises. It is a tricky balance and one of the consequences is that it makes stock markets very sensitive to economic data.

We saw this when the US payroll figures for January were released. It showed Total “Nonfarm Payroll Employment” rising by 517,000, significantly higher than the forecast of less than 200,000.

So, what effect would you expect that to have on the US stock markets? On one level you would have thought that it is good news. More people in employment means fewer people requiring state help, more money for people to spend, and so the economy should grow. Unfortunately, it is not that simple. The counter argument is that inflation has recently been at record highs and is only just starting to ease, even though the Federal Reserve has already been raising interest rates at an unprecedented pace. Having more people employed could increase consumer spending and fuel wage inflation. This would encourage the Federal Reserve to increase interest rates further, putting more financial pressure on households, businesses, and the government.

Although there are probably other factors involved, the US stock market indices, that had done so well in January, fell immediately after the payroll data was announced and have subsequently fallen further.

I believe that markets are likely to remain volatile for the next few months, which is a good reason to be holding cash, but at the same time we need to acknowledge that the worst could be behind us and so there might be a lost opportunity in being overly cautious. These are choppy waters, but under the current market conditions we feel that we have got our weightings about right in our demonstration portfolios.

In the Tugboat, our most cautious portfolio, we have just over 60% in cash or invested in money market funds, down from 90% at the beginning of the year. In our more adventurous Ocean Liner, the figure has dropped to 40% from 80%. For people who are more risk adverse, I can see the benefit of holding higher levels of cash, while the more adventurous may be comfortable having greater exposure to equity markets.

Our largest holdings are still in funds from the Mixed Investment 40-85% Shares sector, the European sectors, and the three UK Equity sectors (UK All Companies, UK Smaller Companies, and UK Equity Income). Although they have gone down over the last couple of weeks, most of these funds are still up over four weeks and they are all up over 12 weeks. We are giving them the benefit of the doubt for the moment.
 
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