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I grew up in Rome, a city inextricably linked throughout its history to politics. It was there that as a teenager 30 years ago I first became interested in current affairs.

At the time, the Italian political framework which had been in place since World War II was being dismantled amid a wide-ranging corruption scandal. Many political parties and senior political figures disappeared as a result.

I have been endlessly fascinated by political, social and economic trends ever since that tumultuous period. Fortunately for me, identifying and understanding these trends is an important part of my job as an investor.

Right now, I believe we are in the middle of a period of profound global change on many levels.

Climate change is making it imperative that the world develops a more sustainable growth model. Income inequality and its negative consequences have been exacerbated by the effects of quantitative easing. The vulnerability of global supply chains has been highlighted by the COVID-19 pandemic and the war in Ukraine.

These three factors are leading to an intense focus on de-carbonization and a reassessment of the risk of global supply chains, as well as much greater levels of government intervention. The impact on how we need to invest is far-reaching.

 

What Does This Mean For Our Portfolios?

First, let’s take the situation in Ukraine following Russia’s invasion. Above all there is the human perspective, which is tragic and horrifying. But our clients also need us to examine it from an investment perspective. This means we need to step back and focus on the medium-term implications of the conflict. This translates as more supply disruption across a broad range of commodities and a greater focus on Europe’s energy security. Coinciding with a global focus on net-zero targets and the energy transition, this means commodities and resources markets are being pulled in opposing directions.

We've long argued against an exclusionary approach to meeting net-zero commitments. This is because we need to also ensure that our portfolios have sufficient flexibility to cope with different market environments and time horizons. 

The path to decarbonization was never going to be linear. Right now, there's a case for owning commodity-related investments as a potential hedge against inflationary pressures. However, we should also be investing in the energy transition which, more than ever, remains a strategically important area. In many instances, through an active approach, we believe we can identify investments that serve both objectives. 

Second, there's the prospect of rising rates in the face of rising inflation. Although technically base effects may lead to inflation peaking later this year, central banks around the world are acutely aware that they are behind the curve and are moving to tighten monetary policy.  

We’ve previously talked about how with interest rates at zero the old proverb of “a bird in the hand is worth two in the bush” became untrue. That’s because the bird in the hand (cash or bonds, for example)  was worthless, so investors were forced to invest in riskier assets (the two in the bush) to generate returns. However, rising rates now pose a challenge to returns from risk assets. That is, the "bird in the hand" starts to be worth something.  

 

FIGURE 1

% Change in Commodity Prices From January 2022 Averages

Past performance does not guarantee future results. For illustrative purposes only. As of 3/24/22. Source: Schroders Economics Group.

 

While the last 10 years have been characterized by tight fiscal policy and loose monetary policy, this status quo is set for a turnaround. With a more interventionist approach from the government being accelerated by the pandemic and geopolitical conflict, we are seeing a return to looser fiscal policy and tighter monetary policy.

Bond prices have fallen dramatically over the last few months, with the US 10-year Treasury yield rising from a low of 1.20% in 2021 to more than 2.75% and the 10-year German bund rising from -0.70% to 1.10%. 

 

FIGURE 2

Drawdown on US 10-Year Treasury Yield

Past performance does not guarantee future results. Data as of 3/31/22. Source: Schroders and Refinitiv.

 

We expect equities to be caught between the crosscurrents of rising interest rates and commodity prices, leading to the expectation of more muted returns this year.

 

Similarly, the yield on the Bloomberg US Credit Index1 has risen from 1.75% to 4.11%.* Percentage changes such as these haven't been seen since the 1980s. At these levels we would argue that the traffic signal for bonds is moving from red to amber.

What prevents us from getting more bullish is that investors will require more yield to compensate for the increased volatility. We also need to keep a close eye on European bond yields which have now moved into positive territory, as this removes an important underpinning for global yields.

Equity markets have bounced back from oversold levels as investors have become more accustomed to pricing in the risk of the war in Ukraine. Although the news is bleak, we now have more information on the reaction functions of Russian President Vladimir Putin and NATO. However, the risk of an even more significant escalation can't be discounted. 

At an index level, we expect equities to be caught between the crosscurrents of rising interest rates and commodity prices, leading to the expectation of more muted returns this year. However, below the surface, we still see opportunities for more value-oriented investments. Looking at the last 20 years, there's still plenty to go for with this trend.

 

It's a time for investors to consider what they did in their portfolios over the last 10 years— and then consider doing the opposite.

 

In short, it's a time for investors to consider what they did in their portfolios over the last 10 years—and then consider doing the opposite. 

Investors need to consider taking a forward-looking approach and to expect the unexpected. They might be well served by following the White Queen’s instructions to Alice in the Lewis Carroll novel Through the Looking Glass and think of "as many as six impossible things before breakfast.”

 

* Past performance does not guarantee future results. Index data as of 5/31/22. Indices are unmanaged and are not available for direct investment. Source: Bloomberg US Credit Index and Hartford Funds.

Talk to your financial professional to discuss how to help position your portfolio for a difficult economic environment.

 

1 Bloomberg US Credit Index measures the investment-grade, US dollar-denominated, fixed-rate, taxable corporate and government-related bond markets. It's composed of the US Corporate Index and a non-corporate component that includes non-US agencies, sovereigns, supernationals and local authorities.

Important Risks: Investing involves risk, including the possible loss of principal. Security prices fluctuate in value depending on general market and economic conditions and the prospects of individual companies. • Fixed-income security risks include credit, liquidity, call, duration, event, and interest-rate risk. As interest rates rise, bond prices generally fall. • Investments linked to prices of commodities may be considered speculative. Significant exposure to commodities may subject an investor to greater volatility than traditional investments. The value of such instruments may be volatile and fluctuate widely based on a variety of factors.

“Bloomberg®” and any Bloomberg Index are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indices (collectively, “Bloomberg”) and have been licensed for use for certain purposes by Hartford Funds. Bloomberg is not affiliated with Hartford Funds, and Bloomberg does not approve, endorse, review, or recommend any Hartford Funds product. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to Hartford Fund products.

The views expressed herein are those of Schroders Investment Management (Schroders), are for informational purposes only, and are subject to change based on prevailing market, economic, and other conditions. The views expressed may not reflect the opinions of Hartford Funds or any other sub-adviser to our funds. The opinions stated in this document include some forecasted views. Schroders believes that they are basing their expectations and beliefs on reasonable assumptions within the bounds of what they currently know. The views and information discussed should not be construed as research, a recommendation, or investment advice, nor should they be considered an offer or solicitation to buy or sell any security. This information is current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Schroders or Hartford Funds.  

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Insight from sub-adviser Schroders Investment Management
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Group Chief Investment Officer and Co-Head of Investment

 

 

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