Market Commentary – 3rd October 2022
After a couple of summer months when markets seemed to stabilise, the autumn has so far brought with it an unwelcome return to rising bond yields, declining equity markets and freefall in our currency. The Queen’s death on 8th September, just two days after Liz Truss became our new Prime Minister, united the country in its grief for a period of national mourning and there was no other news to speak of. Since then, politics has returned with a vengeance and the new Chancellor’s so called, but anything but, mini budget has dominated headlines and the airwaves. A U-turn on the proposed abolition of the 45p tax rate, announced this morning, has given traders a reason to buy the pound, after a precipitous fall against the dollar but ongoing uncertainty seems likely if the government forges ahead with other sweeping unfunded tax cuts requiring record levels of borrowing.
It is tempting to pin everything on the new government and whilst their actions have given market participants plenty of reasons to judge them reckless, the challenges they face are global. After more than a decade of ultra-low inflation central bankers around the world are now grappling with the opposite problem – how to curb rampant inflation without crashing their economies. Soaring energy prices, particularly in Europe, caused by years of under-investment in fossil fuel extraction as countries target net zero and exacerbated by the war in Ukraine, has been one of the main culprits. With the exception of Japan, developed economy central banks have embarked on an aggressive tightening regime, with rapid rises in interest rates. This has caused bond yields to rise and prices to fall. At one point in the last week, an unprecedented intra-day rise in UK gilt yields meant that pension funds which have adopted a liability driven approach were having to sell gilts in order to meet margin calls which put yet more downward pressure on prices, a circle so vicious that the Bank of England was forced to intervene and spend up to £65bn purchasing bonds to prop up the market.
Growth is looking increasingly precarious and whilst there were signs of inflation easing over the summer, the latest data and the accompanying rhetoric from the US Federal Reserve is fuelling negative sentiment and although labour markets have remained robust in both the US and UK, record levels of employment intensify fears of a wage price spiral and the unemployment rate is widely considered to be a lagging indicator.
Since our last update in mid-August the US dollar has continued to strengthen, rising a further 8.60% versus sterling to 30th September 2022, the last full data point we have, although the pound has bounced off its intra-day low of $1.0327 early last week, an all-time low since decimalisation in 1971. This, coupled with ongoing inflation of close to 10%. has led to fears that the Bank of England will be forced to raise rates faster than anticipated with the biggest casualty being government bonds. The FTSE Actuaries UK Conventional Gilts All Stocks index has fallen 14.38% bringing the year-to-date fall to 25.10%. This is nothing less than extremely painful for holders of what is usually regarded as a safe-haven asset. Equities have also suffered but not quite to the same degree. The FTSE 100 has fallen 7.69% in the past seven weeks but only 3.66% year to date. Meanwhile the S&P 500 has declined by 9.55% bringing its year-to-date fall, in sterling terms, to 7.95%. However, remove the effect of currency and the S&P 500, when expressed in dollars, has in fact fallen 24.14% year to date, putting it firmly into bear market territory. This has been driven by its concentration in growth-oriented stocks, in particular technology companies, compared to the more value-oriented FTSE 100 which is more heavily weighted towards energy, materials and financials which tend to fare better in an inflationary environment. It should also be noted that whilst sentiment towards the UK is currently extremely pessimistic, the UK stock market is made up of many companies with earnings derived from overseas.
For bond investors, it is worth pointing out that whilst the recent sell-off has been brutal, over three years to 30th September, global equities1 have risen 23% whilst gilts2 have fallen 26%, suggesting that some negative correlation persists and that if we enter an economic recession then holding a diversified portfolio of different asset classes should remain a sound long term strategy.
There is little doubt that financial markets are fragile and high levels of volatility are likely to persist with the likelihood of further downward shifts in asset prices. It’s an old adage but markets really don’t like uncertainty and tend to over-react. It is currently extremely difficult to unpick the likely path of inflation, the final level of interest rates and the depth of any recession. This can throw up opportunities at a stock level but extreme moves like the ones we have seen in the past few weeks make trying to time moves in and out of asset classes even more of a challenge and one best left to hedge funds and the like.
Our next quarterly investment strategy committee meeting takes place next week when we will be reviewing all our portfolios and underlying fund recommendations in depth and discussing the outlook. We look forward to reporting back on any developments.
At the risk of sounding like a stuck record, we would like to remind clients that the best way to achieve their investment objectives over the longer term is to remain invested in portfolios that are diversified across different asset classes, geographies and investment styles and which are commensurate with their capacity for loss and appetite for risk.
(1 MSCI ACWI, 2 FTSE Actuaries UK Conventional Gilts All Stocks index, Source: FE Analytics, Bid to Bid, Total Return, GBP, 30/12/2021-30/09/2022.)
3rd October 2022 RiverPeak Wealth Limited