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Investment market commentaries are often criticised for telling you what you already know. However, I reckon most investors pay little attention to month-by-month market movements, so such missives are an important regular update if only to say, “everything’s going according to plan”. That said, there are periods when markets defy the most sensible strategies, and there is nothing like a sizeable drop in a portfolio valuation to focus one’s attention. At that point, we want opinion (if not comfort) about potential resolution – however, educated those guesses. Let me try and satisfy both needs.
Fastest reversal in fiscal policy in UK political history
After the rather shocking events post mini-budget, October’s virtual regime change saw probably the fastest reversal in fiscal (ie taxation, borrowing and spending) policy in UK political history. As a reminder, the independent Bank of England (BoE) is responsible for monetary (ie pursuing price stability through managing money supply, and setting interest rates) policy. The Truss team’s expansionist ‘plan’ ran counter to the BoE’s objective; hence the world saw the UK finances taking a further nose dive, and the nation’s creditworthiness accompanying it.
Less than 4 weeks later, we have a new PM and chancellor, and a new plan due to be announced in mid-November that has to mitigate a £40bn hole in the UK accounts, while recognising the so-called ‘cost of living crisis’. It has to be said the ship has more than steadied since September 27th: Index-Linked Gilts are up 28%, conventional gilts over 11% and UK corporate bonds almost 8%. There is still some way to go on the road to recovery, but investors who panicked and sold out on the Monday 26th must be kicking themselves.
As for Equities, other than in Far Eastern Markets most of the world saw positive returns through October (even the UK’s AllShare Index was up 4%). So what is the outlook from here?
Rising interest rates
The US Federal Reserve raised interest rates by another 0.75%, and Fed Chair Powell made it clear the peak for their rates might be higher than anticipated and occur later than many have predicted. I take that as a ‘ticking off’ for markets, ie not to assume the Fed cares more about people’s short-term sense of wealth than bringing down inflation. Clearly, the Fed will have to think about ‘pausing’ interest rate rises at some point; the threat of recession acts as a brake on rate rises because central banks know the inflation-dampening consequences of those increases take effect with a lag, rather like steering a supertanker - they are likely to be more guarded about rate rises from here in case of “oversteer”, ie raising by too much, which would have a socially destabilising effect.
The BoE has said as much. As I write this the Bank has raised rates by another (widely anticipated) 0.75%, but Governor explicitly claimed that they are unlikely to raise rates to the market’s predicted level of 5%. This is because the UK has to all intents and purposes fallen into recession already, and one which may last some time.
At this point it's worth noting that interest rates are typically higher than the inflation rate – since the Bank of England’s inception in 1694, that has been the case in 244 of those years. However, since 2008 the opposite has been true; quantitative easing and COVID saw interest rates ‘artificially’ depressed. Now any GCSE Maths student will tell you that a series of numbers that are extreme deviations from the average are likely to be followed by a less extreme event – this is known as reversion to the mean. In the modern era (ie since 1945) the average ‘gap’ between the interest rate and inflation is just under 1%, in other words, you should normally expect interest rates to be roughly 1% higher than the inflation rate. The market is now pricing a maximum interest rate of 4.5% by mid-2023. Since the BoE inflation rate target is 2%, this implies a ‘target’ interest rate in a period of economic stability to be 3% - ironically where it is now.
As for recession, you might be surprised to learn that it is not a ‘given’ that stock markets fall in an economic slump. Markets anticipate as well as react; generally, equities reach highs months before a recession starts – the ‘top’ at the start of this year fits the pattern. Similarly, a market bottoms out some time before the end of a recession. Indeed, over half of US recessions since World War II have seen the S&P 500 post positive returns over that period.
The value of advice
While investment portfolios may not have behaved according to plan so far this year, the fact that you have an adviser to help navigate turbulent waters will continue to be of great value. The long-term financial plan is paramount. Former Five-star General and US President Dwight Eisenhower once opined that while no battle was ever won according to plan, no battle was ever won without one.
See you next month,
Investment Director - Ascot Lloyd
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