Please find below our Investment Market Update as at 16th September 2022.
What a few days it’s been!
Very surreal in so many ways.
After showing respect last week to the passing of HM the Queen, it is time to get back to giving you a steer on what’s happening out there in the big wide world of politics, economics and the markets.
Liz Truss and her actions; good or bad?
It didn’t take long for Liz Truss to spring into action and deliver on the promise to address the energy crisis. After weeks of no effective leadership, something had to be done! On the face of it, her actions were good news, although the help to businesses was deemed to be largely viewed as a disappointment. Six months will fly by!
What are the broader implications?
Some economists have warned that due to Truss’s energy package, the Bank of England (BoE) may be forced to raise interest rates higher – up to 4%. That is more than double the current rate of 1.75%. They have already raised rates six times to 1.75%. Extraordinary!
The announcement has prompted economists to warn that price pressures will embed in the economy. It has been suggested that the package will have the effect of watering down incentives for households to cut spending by pegging energy prices. This could create added inflationary pressures although, personally, I believe that emotionally, consumers will be prudent.
The alternative, however, is that the UK population could face the worst hit to their living standards on record. Truss’s package will artificially keep reported inflation lower than forecast due to it transferring costs from businesses to the government’s balance sheet.
A recent Reuters poll suggest that the BoE base rate is likely to rise by 0.5% next week up to 2.25%.
UK Inflation Chart
Is it any easier in the US?
In some ways it should be, as they have a more robust energy programme than us here in the UK. However, with a buoyant economy, the powers that be need to ‘lower the heat’ and restrain inflation. The Federal Reserve (Fed) have been heavily criticised for their delayed response, but several factors transpired to create a ‘perfect storm’ on the economic front. After clamouring for inflation in 2020, the opposite is true today. It is the enemy!
Good news… US unemployment rises!
Like with many things at the moment, this seems like a contradiction. Normally, a rise in unemployment is exactly what the authorities don’t want as we head for a recession. Quietly, the news that unemployment rose to 3.7% in August was welcomed.
To make inroads into tackling inflation, the unemployment figure needs to rise to weaken strong pay rises. Data shows that there are about two job vacancies for every unemployed worker, suggesting little softening at present.
This in turn suggests further strong rate hikes by the Fed.
Higher inflation in the US spooks investment markets
After a recent dip in equity prices, the signs were encouraging as markets recovered lost ground, that was until the latest inflation figures were announced. The general expectation was that inflation would have weakened but data showed it rose. Only by 0.1% but the markets were anticipating an inflation rate of 8.0% but instead it came in at 8.3%.
Futures markets, as a result, began pricing in a 0.75% basis point rise next week.
The manifestation was that all three major stock market indices in the US fell sharply after four days of positive gains, registering the biggest one-day percentage falls since June 2020.
It’s worth remembering regardless, that the Fed Chairman stated recently “we need to see a string of slowing inflation data before aggressive interest rate hikes are tempered”.
How quickly things can change!
Something I’ve spoken about on many occasions. Citi, the Investment Bank, featured as one of the main headline makers recently when they proclaimed that inflation levels could rise to over 18% here in the UK. Following Truss’s energy announcement, they now believe that inflation could peak at 11.7% in January 2023.
I also suggested a few Commentaries back, that the sooner interest rates go up the better. I know this will be painful for borrowers, but aggressive hikes now, will avoid the long-term pain that lofty and persistent inflation brings. This sentiment is now being voiced from a number of quarters, and consistent with Citi’s analysis, there are now stronger noises that inflation could peak by the end of the year.
If inflation did peak at the turn of the year, remember what the Fed Chairman said about needing to see a string of slowing inflation data.
However, should this happen, we expect equities to undertake a quick step change. The news flow will likely be awful but as we know this is when the best opportunities for strong gains often present themselves.
What sectors are looking attractive?
Earlier in the week I read an interesting article in Investment Week about healthcare and how the sector is set to get a boost, after a survey of institutional investors across Europe, Asia and US by BNP Paribas Asset Management.
The survey, which examined how demographic change has and continues to impact asset allocation, revealed healthcare was a sector of significant interest. The growing enthusiasm for this sector was due in the main to the pandemic and climate change.
The majority in the survey cited the acceleration of digital and new technologies as an important change that was shaping investments (95%) followed by the impact of ageing populations (91%), changes to consumer habits (89%) and population growth in emerging markets.
Our in-house Global Themes portfolio is particularly well positioned to take advantage of such changes.
Infrastructure to the rescue?
There have not been many hiding places this year, but we have used alternative assets like infrastructure to offer diversification and a more predictable investment pathway. That’s not to say it’s straightforward. Far from it, but as Rob Morgan, the Chief Analyst at Charles Stanley Direct stated recently, “on a risk reward basis, infrastructure has been one of the best asset classes this year”.
He went onto say that the Clearbridge Global Infrastructure Income fund which has lots of overseas diversification, with the ability to tap into reliable income streams that are resilient to inflation, was highly desirable. This fund currently constitutes 25% of our Infrastructure portfolio and 20% of our Momentum portfolio.
He went onto say that he liked this fund because “it offers exposure to the broad and varied listed global infrastructure asset class. The management team is made up of experienced specialists that have built an impressive record. Around 90% of underlying revenues in the portfolio are inflation linked, so the income and the portfolio could be relatively resilient whatever is thrown at it”.
This was all spoken about in context of Truss’s lack of wriggle room on taxes now she has committed to a huge energy package. In effect this will prove inflationary and places greater pressure on the BoE to keep interest rates higher for longer.
A new form of capitalism?
A more uplifting story from Patagonia founder Yvon Chouinard. The news broke yesterday and was reported in Bloomberg that the rock climber who became a reluctant billionaire will pass ownership of his 50-year-old outdoor apparel firm to a trust and the company will be run as a non-profit organisation, devoted to protecting the environment.
At first glance it is easy to think ‘well he can afford it being a billionaire’, but his journey has been authentically embedded in principles which are now becoming the foundation of ESG (Environmental, Social, Governance).
The transfer is valued at circa $3 billion according to the New York Times. “Hopefully this will influence a new form of capitalism that doesn’t end up with a few rich people and a bunch of poor people” said the 83-year-old, Chouinard.
Uncertainty reigns but there are some encouraging signs that inflation may peak sooner than was previously anticipated. The main question thereafter is, “will inflation remain stubbornly high”? Interest rates may still be rising after the peak to ensure high inflation isn’t embedded into economies.
Aggressive interest rate hikes will undoubtedly be painful but hopefully this will be short lived, and we can expect interest rate reductions thereafter. It’s worth remembering that the Fed and BoE are both targeting 2% inflation in 2024!
Investment markets reacted negatively earlier this week to stronger than expected inflation figures in the US. The data however showed there was only a 0.3% increase in inflation. It’s worth stepping back and evaluating how the markets would likely react in a few months’ time if inflation data turned out to be better than expected!
Whilst we have had a sombre week, it is uplifting to see an outpouring of respect for Queen Elizabeth II. The funeral on Monday will mark the end of the 10 days of public mourning.
Normal service will resume after Monday, whatever ‘normal’ is nowadays!
Best wishes for the weekend.
Gary and the Blue Sky Investment Team
Please Note: This communication should not be read as giving specific advice regarding your personal circumstances. This would only be given following detailed assessment of your individual needs. The value of investments may fall as well as rise; you may get back less than invested. Past performance is not necessarily a guide to future returns.