• The war in Ukraine and the legacy of the pandemic have created real world consequences for many US companies
  • Markets have flipped between value and growth depending on their view of interest rates and inflation
  • At an uncertain time, holding good companies at fair valuations is a sensible approach

      These have been unsettling and uncertain times in financial markets. The war in Ukraine, coming so quickly after the pandemic, has created real world financial consequences for many US companies – from supply chain disruption to rising energy costs. This has created significant volatility, which has seen markets flip from one investment style to another and back again as investors try to predict the longer-term impact on the economy, interest rates and inflation.

      At the moment, it is difficult to see beyond the crisis. Commodities markets remain in disarray as the conflict continues. Price rises started to stabilise in the second half of March, but until there is some clarity on the outcome, energy and food prices are likely to remain volatile. This feeds into higher inflation across the world and dampens consumer spending.

      The crisis also exacerbates existing problems in global supply chains. The pandemic has seen real difficulty in getting goods from place to place. It only takes one missing piece to disrupt production of goods. While companies are re-engineering their supply chains, this takes time. Supply chain disruption is likely to last for at least another six months and possibly far longer.

      Inflation and interest rates

      This creates a tough environment for inflation. US CPI now sits at almost 8% and this persistent high inflation is informing central bank decision-making. There had been some speculation on whether the Federal Reserve might rein back on rate rises to mitigate the increased cost of living, but it raised rates in March and maintained its guidance for six or more rate rises in 2022. The market agrees that this is the most likely outcome.

      The ’value’ investment style may do well at a time of higher inflation and rising rates, while ‘growth’ may do well if inflationary pressures ease. Markets have reflected this tension, flipping between these two styles depending on their view of inflationary pressures. While there are arguments for either outcome, we believe it is dangerous to rely on low rates to support stock valuations. In particular, the strong performance of the mega-cap technology stocks has been supported by a low rate environment, which cannot be assumed in future.

      The right approach?

      Ultimately, trying to predict the ebb and flow of central bank actions is a thankless investment strategy. We believe the most sensible path is to own good companies at fair valuations. The recent dislocation has created far more opportunities to do this as higher quality companies have sold off alongside weaker companies.

      What defines ‘good’ in this environment? With supply chains under pressure, it is the largest companies with the most buying power that will get their products first. Companies will not upset their biggest customers. Also, companies need to be able to pass on higher input costs to their customers. This option is only available to those companies with pricing power. These two elements are a priority in all our investment selection today.

      Equally, there are sectors that are less sensitive to the economic environment. Pharmaceutical companies, for example, are benefiting from rising demand for healthcare and drugs. They have proved good at recycling their cash flows into new and innovative areas. AbbVie and Bristol Myers Squibb are the largest holdings in the Abrdn North American Income trust.

      The financial sector has consolidated and strengthened and remains our largest sector weighting. During the financial crisis, banks were the problem. During the pandemic, they have been part of the solution, helping out small business with loans. They should also be a beneficiary of higher interest rates. Again, high quality is important – we hold groups such as Citigroup in the portfolio.

      We believe dividends will become important in a way they haven’t over the past few years. Income from fixed income remains low and the value emerging in some dividend paying companies is increasingly hard to ignore. Dividend growth is moving higher, with most companies raising dividends as their earnings improve. Yet dividend paying companies have remained significantly out of favour with investors.

      There is a lot of value in the US market, and investors don’t have to look very hard to find it. In this uncertain environment, it is important not to focus on the likely trajectory for interest rates or inflation, but instead look for those companies that are strong enough to withstand a range of economic environments. This is where we are focusing our efforts on the North American Income Trust today.

      Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

      Important information
      Risk factors you should consider prior to investing:

      • The value of investments and the income from them can fall and investors may get back less than the amount invested.
      • Past performance is not a guide to future results.
      • Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
      • The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
      • The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
      • The Company may charge expenses to capital which may erode the capital value of the investment.
      • Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
      • Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
      • There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
      • As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
      • The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
      • Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
      • With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘sub-investment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
      • Yields are estimated figures and may fluctuate, there are no guarantees that future dividends with match or exceed historic dividends and certain investors may be subject to further tax on dividends.

      • Other important information: Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.
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