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In October, our fourth unmandated leader in a row rose from the subs’ bench, and to the relief of bond and equity markets managed to deliver the Autumn Statement. While reassuring markets, the leadership is still some way short of restoring the economic stability which has been self-proclaimed by the Conservative Party. The Office of Budget Responsibility has warned that the UK will suffer the most severe plunge in living standards since the records began in 1956, with household disposable income predicted to fall by over 7% by the end of 2024.
Despite the UK economy growing by more than 4% this year, it is likely already in recession (having two consecutive quarters of economic contraction) and expected to shrink by 1.4% next year. The UK will not be alone in that regard; the International Monetary Fund (IMF) anticipates that one third of the world will be in recession by the middle of 2023. Inflation meanwhile continues to rise, the UK headline inflation rate already passing 11% with the perceived driver being utility prices. However, among the detailed figures, we note that during October food prices were almost 17% higher than a year ago.
Yet despite these somewhat gloomy pronouncements, during the month it became clear that much of the 2022 market falls were perhaps overdone. Despite further interest rate increases at the beginning of the month in both the US and at home, markets were encouraged by US inflation data that hinted ‘peak’ inflation had arrived, by extension implying that the pace of future interest rate rises would slow. Since the Bank of England’s ultimatum to Pension funds in mid-October, index-linked gilts have risen over 24%, while conventional gilts and corporate bonds have grown by 14%. UK shares are up too, the index of our largest 350 companies having gained around 15%, while most if not all assets’ valuations have improved significantly over their worst levels in 2022. Asia equities rose a whopping 19% in November alone, in part reflecting hopes that China would relax its draconian COVID laws following the introduction of a more intensive vaccination programme.
Readers will be reminded that we counselled patience amid the rout and maintained our view that prices of bonds in particular were too low, offering new investors a rare opportunity while existing investors would see the start of a recovery. The regret being felt by investors who crystallised losses and panicked into cash will be acute.
Moving on swiftly, and given this is December, many commentators with too much spare time on their hands will already be starting the annual round of utterly pointless predictions of market levels to be achieved by year end 2023. This is all good column filler but quite why performance between January 1st and December 31st is any more important than between December 1st and November 30th remains a mystery. It may not be a surprise to learn that for the first time in several decades, the widespread view is that the world’s largest equity market (the US) will decline next year rather than rise and by around 2.5%.
However, what exercises our investment thinking is rather less about index levels, and not even the (all but certain) likelihood of recessions, but rather their depth and length and the degree of ‘overreaction’ – from despondency to exuberance - they are likely to produce in investors. Any signs that interest rate policy is dampening inflation should naturally point to consequent interest rate reductions and positive market responses. On the other hand, any policy mistakes (eg maintaining higher interest rates for too long) can unnecessarily prolong and deepen the recession and delay a return to economic growth, with a significant negative impact on sentiment.
The latter is much of what drives markets in the short term. It is assumed that recessions are bad for companies’ earnings (ie revenue), and hence share prices (which rationally should equal the net present value of future earnings). If you compare the long-term trend in companies’ earnings growth, with the growth in the equivalent share price index, they are very closely correlated. It is fair to say that over the long-term, earnings growth explains the vast majority of stock market growth. However, in the shorter-term, the ‘multiple’ that investors are willing to pay for those future earnings - how many years’ worth of earnings repays the share price you paid - fluctuates wildly depending on many other variables like interest rates, inflation, geopolitical developments and frankly just plain fear and greed. In other words, knowing what earnings will be tells you nothing about where the index will be.
Investment (versus speculation) remains about the long-term, and history shows repeatedly that the odds are patience will be rewarded with excess returns. Now speaking of speculation...
The world’s largest lottery jackpot, a threefold rollover, was won in November by a Californian individual who staked $2 on a Powerball ticket. Their winnings, invested in US Treasury Bills, will produce a risk-free income equivalent to $166,000 ...each day. Given the odds of winning Powerball are around 300 million to one, the return was over three times what the odds promised.
As we look forward to Christmas and 2023, as they say in the Hunger Games, may the odds be ever in your favour.
Investment Director - Ascot Lloyd
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