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The market has spent the first half of 2022 reflecting investors’ collective hopes that central banks - and in particular the US Federal Reserve - would err towards more dovish policy given the relative strength of the US economy (despite two quarters of negative growth). So, when US economic data in the first half of August appeared to support the view that the gentle pace of their economic slowdown would result in a so-called ‘soft-landing’, ie the avoidance of an outright recession, we saw initial market gains supplementing those made in July, as investors began to believe that interest rate rises would be limited. The S&P 500 rallied, hinting that the 2022 bear market may have ended.
In the first two weeks of the month the American continents’ markets ‘bounced’, Latin American markets rising in aggregate by 9% while the US S&P 500 gained 5%, but global markets were rather less enthusiastic, with the UK and Europe having particular domestic issues to face. In the UK, as inflation reach double-figures (and highest for 40 years) the month began with a 0.5% interest rate increase. The 10-year gilt, which was yielding 1.8% at the beginning of the month, is now 3.2% and prices have fallen by ~11%.
In my experience, the majority of market players (and politicians) have no direct experience of a significant inflation rate and its malign longer-term effects on growth, upward pressure on wages and ultimately the threat to the well-being of society at large. An independent central bank’s key responsibility however is to pursue price stability, allowing economic performance to blossom. It couldn’t care less about stock market performance or unemployment in the short-term and has no such accountability. Employment creation and economic growth are considered by-products of a low single-digit inflation policy, rather than objectives in themselves.
US Federal Reserve head Jay Powell’s speech to the annual gathering of the world’s central bankers at Jackson Hole, Wyoming was therefore hotly anticipated. Observers were looking for signs that the Fed would ease its policy on interest rates. However, Powell made it clear that the Fed “must keep at it until the job is done” and that successfully reducing inflation would result in lower growth for an extended period. He went on to warn that interest rates would need to stay at a growth-restraining level “for some time”. There was no indication that easier monetary policy was in sight, indeed another 0.75% increase seems inevitable at the next Fed meeting.
Markets fell dramatically as a result, wiping out August’s earlier gains. Rather than a return to ‘normal service’, the market now perceives upbeat news on economic growth as a negative, because it is clear the Fed sees this as increasing inflationary pressure, thus preventing a speedy return to lower interest rates. This also implies increasing dollar strength, which in turn puts pressure on the European Central Bank and the UK’s Bank of England to raise rates to prevent associated weakness in the Euro and Sterling. The UK’s 50bp rise at the start of the month appears unlikely to be the last.
However, there are positives to consider. The rate of inflation and commodity prices are closely correlated, and the latter have fallen recently precisely because of the threat of recession – oil is down 20% and the overall commodities index has fallen 16% since mid-June. The index of global supply chain pressure index has eased significantly in August, while small business surveys in US suggest companies plan to cut prices.
Sterling’s weakness relative to the dollar means US investments perform better, since those dollar-valued holdings will convert into more pounds. Similarly, sterling depreciation will underpin and enhance earnings for the roughly 70 FTSE 100 constituents that derive a large proportion of revenue denominated in US dollars.
As an incidental, Bitcoin is down almost 50% this year, finally demonstrating cryptocurrency may not be the inflation hedge its disciples declared it was.
Boris Johnson exited stage right when just under 0.2% of UK registered voters elected a former President of Oxford University’s Liberal Democrat Society as Conservative party leader, and coincidentally our new Prime Minster.
To vanquish the cost-of-living crisis, former management accountant Liz Truss has offered a £120bn programme to cap energy prices funded by borrowing rather than a windfall tax on energy companies, notwithstanding reversal of the planned National Insurance hike and further promised tax cuts worth perhaps 70bn.
Against a background of a forecast 13% inflation rate, further interest rises and real wages falling at their fastest rate on record, one has to hope that Ms Truss’s plan to “hit the ground running” bears fruit quickly. She and her new government have much work to do.
I wrote the bulk of this commentary before we heard the sad news of the Queen’s death. Like 85% of the population I have known no other sovereign or style of monarchy. Over her 70-year reign the country and the world have witnessed some of the most profound changes in human history: from the discovery of the structure of DNA in 1953, space flight, the arrival of the personal computer and the creation of the internet, alongside countless global conflicts and disasters, nevertheless £1 the UK stock market would have grown to more than £2,500 – while £1 in 1953 is worth around £30 today. That’s a pretty good real return, ie a 7% per annum increase in purchasing power. Elizabeth II was the epitome of unwavering duty and service – a commitment she made to the nation as a very young lady and honoured unwaveringly, with patience and discipline. As I’ve alluded to previously in these commentaries, those are attributes every investor would be wise to acquire.
Until next month...
Investment Director - Ascot Lloyd
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