Stagflation worries mount amid latest energy drama; Value funds head off in different directions

Round trip

It’s been another dramatic day for energy prices: UK natural gas contracts for November delivery rose almost 40 per cent earlier, before ending the day more or less flat following conciliatory noises from Russia.

The energy price crisis has been affecting equity and bond markets for several days now, and this latest move was no different. Ten-year gilt yields jumped to 1.15 per cent, the highest level for two-and-a-half years, before retracing all of that move.

Equity markets weren’t quite so fortunate: the FTSE 100 and FTSE All-Share both finished the day more than 1 per cent lower.

For once, it may be shares that are telling the real story. Because while today’s gas price spike ultimately proved short-lived, the direction of travel in recent weeks is clear.

The increase in UK energy price cap scheduled for next April is becoming an increasingly significant date. As it stands, a sizeable jump is almost certain, with all that implies for inflation levels and consumer confidence.

The UK may face many of its own challenges, but it’s far from alone in confronting some of these issues.

We’ve discussed the prospect of stagflation a few times in the past few weeks. Not everyone thinks that’s a likely outcome. But worries are on the rise nonetheless, amid a general sense that investors have been blindsided: there have been more mentions of the word in the past five weeks of the FT’s output than there were for the rest of 2021 combined.

What allocators might do about that remains up for debate. Last Thursday we made mention of one idea: defensives and stocks with high pricing power. But buying those at a time of rising bond yields would require a steely determination.

Bank on it

Those rising yields mean value shares’ relative merits continue to move back up allocators’ agenda. But there’s another caveat to go with the one we mentioned last week.

As some have highlighted, value shares’ recent bounce hasn’t been as significant as you’d expect under the circumstances.

That’s partly because of a general risk-off sentiment. It also has to do with individual sector performance, as the FT emphasises today. At a time when bond yields are spiking, rate sensitive sectors like banks are taking off again. Yet value stocks that do well when growth is on the up, like industrials, have understandably suffered.

The charts provided in that piece are based on S&P 500 performance, but the same dynamic applies on these shores. And there are knock-on effects for fund managers.

Some of the most popular value picks in DFM portfolios have performed even worse than regular UK indices over the past month, and in most cases they tend to have notable weightings to industrials. Polar Capital UK Value Opps, for instance, had a relatively high capital goods position (14.9 per cent) at the start of September.

At the other end of the scale, those who are banking on the banks have performed relatively well. This split naturally favours value-oriented equity income funds such as those run by Gam and JOHCM – and the sector as a whole tends to have more in banks than industrials when compared with growth counterparts.

But there are UK All Companies funds in this group, too: Schroder Recovery, for instance, which has around 22 per cent in financials but much less in industrials.

Even trackers have been able to take advantage in certain cases. The MSCI UK Value Weighted index is much more skewed to financials (27 per cent) than it is industrials (6.3 per cent). And the likes of Dimensional UK Value have similar weightings, which means its relative performance has also held up well enough.