Please find below our Investment Market Update as at 2nd December 2022.
Following on from my comments in recent weeks, we are seeing better news on inflation, the rate of interest rate hikes and, despite the unrest reported in China, better news from the Far East too. However, the impact of rapidly rising interest rates on households and businesses across the western world is yet unclear despite much conjecture.
Pick n’ mix
I’m referring to the outlook for interest rates here and the recent comments from central bank officials in the US.
Towards the end of last week and the beginning of this, the rhetoric was mixed across members of the Federal Reserve Committee (Fed) according to Bloomberg:
- John Williams now sees rates going a bit higher than he envisaged two months ago, thanks to a stronger demand for labour and somewhat higher inflation
- Thomas Barkin favours slowing the pace of rate hikes, but expects peak rates to be higher than he thought a few months ago
- James Bullard stated that investors underestimate the chances the Fed will need to stay aggressive next year.
Only two days later Jerome Powell, the Head of the Fed, signalled that the Fed is ready to slow its tightening pace, potentially starting in December. “The magnitude of subsequent hikes matters less than the ascent’sduration”, he said.
However, it’s always been the case that the Fed requires “substantially more evidence” of moderating prices before they apply the brakes. Powell’s aim, according to reports, was to “pin down a message of no easing in 2023”. In other words, interest rates aren’t expected to fall in 2023.
The markets like Powell’s rhetoric
At least for now. The S&P 500 rose by 3.1% on the back of his statement on Wednesday.
Bond traders have also reduced their expectations for peak rates. They are more optimistic than the Fed’s forward guidance. They appear to be predicting peak rates sometime in the middle of 2023.
It’s likely that it will be a similar story for the UK, although we could be a little further behind the curve than the US due to the UK being less energy efficient and having worse supply chain issues.
Only yesterday, a closely watched US inflation metric revealed that the pace of price growth may be slowing.
The Core Consumption Expenditure Index which measures how much consumers are paying for goods and services while stripping out volatile food and energy costs, rose by 0.2% in October, according to data from the Commerce department.
This was below economist expectations (0.3%) and the 0.5% registered in September. Headline inflation which includes food and energy however, increased by 0.3%.
Later today (Friday) we will be updated with employment data in the US. Remember, the Fed want to ensure that they significantly reduce wage rise inflation. A rise in unemployment is good news.
Consensus says employers added 200,000 jobs in November, slowing from October’s 261,000 but still quite high. The jobless rate is seen remaining at 3.7%. Bloomberg Economics expects that figure to drift up to 4.5% next year.
Rates to be slashed
Bank of America is still a believer in the ‘Fed pivot’, even as Fed officials signal their intentions to keep policy tight next year, according to Bloomberg. They are expecting rates to be slashed in late 2023. Again, ahead of the Fed’s rhetoric.
By way of contrast, Barclays now sees a US recession taking place one quarter later than expected, which should lead the Fed to delay the start of rate cuts.
UK house prices weaken
Of course, with rising interest rates, comes weaker property prices. Confirmation of this in the UK was the latest update from Nationwide. They report that house prices fell by 1.4% between October and November. This was the biggest fall since June 2020 (excluding the Spring Covid period) and it follows the 0.9% reduction the month before.
UK Inflation optimism
We have been of the opinion that UK inflation could fall quite dramatically next year as month-on-month figures drop off the annual inflation rate. We also believe that gas prices will ease (more about that later). This view was reinforced by the Bank of England economist this week.
Protests on the streets
China, the world’s second biggest economy, is forecast to grow at its slowest pace in about three decades as Beijing tries to navigate an exit from President Xi Jinping’s policy of eliminating all coronavirus cases (source FT.com).
Despite suffering its biggest Covid outbreak recently, it looks increasingly likely that Beijing may soften its pandemic restrictions. China’s top zero enforcer has suggested that the fight against the virus has entered a new stage. No surprise after the whole world saw widescale street protests. Embarrassing indeed, for the second largest economy in the world!
Apparently, the Omicron variant is suddenly becoming less pathogenic, and they point to higher vaccination rates.
Analysts at ANZ, the Australian bank, suggested that China was instead shifting to ‘living with Covid’, citing the introduction of rules that allow people to quarantine at home. State media this week also shifted their tone to emphasise that Omicron was less deadly than earlier strains. On Thursday, the state-run Global Times cited domestic research that showed the mortality associated with the Omicron variant had declined.
Smoke and mirrors?
Maybe, but it’s certainly given encouragement to Chinese stocks and the Pacific region. Goldman Sachs now sees a 30% probability of China ending its Covid Zero policy before April – earlier than widely expected.
Good news for Pacific funds which we hold in some of our focused portfolios.
High quality is the focus
Our latest update from LGT Wealth highlights that within their portfolios, they continue to favour high quality businesses that are able to pass on cost pressures to consumers. They’ve also been using the recent ‘pick up’ in equity prices to give greater weight towards the steadier, so called, ‘value businesses’. The thinking is that this will limit the potential downside for a deteriorating business outlook. This is something they are mindful of during a period of both interest rate and economic volatility.
Ultimately, this increases the margin of safety, whilst still benefitting from a large upside should investment markets continue their recent trajectory.
Crisis, what crisis?
I touched on gas prices earlier and I thought you may find this article interesting from Seven Investment Management.
At a time when we are being told to conserve energy and turn down our thermostats, it’s interesting to note that the UK is only one of two countries in Europe that has no further capacity for storing gas. The chart below shows how we fair compared to other EU countries.
So, looking good!
If we now take a look at a map of the English Channel, the busiest shipping lane in the world (with more than 500 ships a day passing between Dover and Calais) it highlights a very different picture to an energy crisis.
There are over 60 tankers moored in the Channel, signified by the red dots on the map below. More than half of these are carrying Liquified Natural Gas, waiting to deposit it into specialist terminals in the UK, France, Belgium and the Netherlands – those green triangles. Some of them have been bobbing around there for over a month.
So, do we have an energy crisis or not? Why aren’t these ships unloading?
Source: 7IM/Bloomberg/ https://www.marinetraffic.com/
There are two things at play here:
Firstly, October 2022 was extremely warm in northern Europe – the seventh hottest since 1884. Lots of those tankers started their journeys (from the US or Qatar) expecting Europe to have already started turning on the central heating. Most didn’t, which meant our day-to-day demand was lower.
Secondly, the campaign to stockpile gas ahead of the winter has been extremely successful. As the table identifies, Europe’s storage is at 94% of total capacity, with the understandable exception of Ukraine. This stored gas, accounts for nearly one third of normal annual consumption for Europe, so those tankers aren’t yet required.
As I have reminded readers on many occasions, data is backward looking, and investment markets are forward looking. It is important to consider how much of the bad news is already baked into market sentiment.
Clearly, there is a lot of money on the side lines waiting to be invested. Equity indices have performed well since the middle of October, but if we get any shocks, say on weaker than expected economic or corporate performance, then this could take prices down further.
Whilst there are some attractive price points in areas of the market, it is difficult to have strong conviction for a sustainable recovery until we have seen the manifestation of rapidly rising interest rates feed through to businesses and the consumer.
Keep warm, and don’t worry about running out of gas!
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.