A mini sell-off has gathered momentum
We didn’t want to be proved right in July of this year when we commented that the summer’s buoyant mood regarding stock market valuations was likely to be short lived, but sadly we have been.
At the time, corporate earnings were holding up better than expected, data was suggesting that inflation was perhaps weakening, there were signs that the oil price was stabilising and as a result, there was an expectation that interest rate hikes would be less dramatic.
We didn’t buy into the ‘bounce’ and decided to sell certain assets instead. In some quarters that seemed controversial but, holding circa 25% in cash in the current market now seems a very wise move. We believed that the impact of rising energy prices, inflation in general, along with interest rate hikes had not really permeated into either the data, nor the psyche of behaviour.
A couple of months on, profit warnings are now becoming commonplace, inflation expectations are still lofty, with many commentators believing that inflation will be embedded for longer and Central Banks are still ratcheting up interest rate rises.
Talking about interest rates, as expected on Wednesday, the Federal Reserve (Fed) in the US increased rates by 0.75% and the Bank of England (BoE) increased rates yesterday by 0.5%.
Interestingly, opinions on the Monetary Policy Committee here in the UK diverged. To be fair, they are united in the direction of travel for interest rates but this time around, five members backed a 0.5% rise, three wanted a 0.75% increase and one member voted for a 0.25% increase.
In the UK, interest rates have now risen from 0.125% to 2.25% in less than a year.
A game of tug and war?
An article in Portfolio Adviser quoted George Lagarias, Chief Economist at Mazars, who described the BoE move as “well within market expectations”.
“The Bank is certainly doing its bit to fight inflation. Having said that, the reality is that the impact of higher interest rates may only be limited. Inflation is much more influenced by global than local factors”.
The BoE’s approach now has another challenge and that is the intervention from the Treasury under the government’s new leadership. The main issue is that the public finances are deteriorating at a time when inflation is rising. Any fiscal stimulus is likely to add to inflationary pressures. A really difficult dilemma.
Ross Mould, Investment Director at AJ Bell, said: “Perhaps the Mini Budget to be launched by the new Prime Minister and Chancellor will offer sufficient fiscal stimulus to compensate for tighter monetary policy, but if that tax-cutting boost stokes demand and further feeds inflation, then the Bank of England will be faced with yet another quandary”.
The government is springing into action
The proposed tax cuts would come on top of the £150 billion of energy crisis aid for consumers, with an energy price cap for households that will fix the typical bill at £2,500 for two years.
The government also announced on Wednesday (21 September), that it would cap wholesale electricity and gas costs for businesses at less than half the market rate from next month, which will add to its fast-rising spending.
An article in Bloomberg today quoted Ben Laidler, Global Markets Strategist at eToro, who said that this “dramatic”spending support will be welcomed in the short-term, but carries risks, such as worsening the UK’s 6% budget deficit and increasing its near 100% debt/GDP level.
On Wednesday, the Institute for Fiscal Studies think-tank and Citi released a report which stated that the planned permanent tax cuts, alongside rises in the cost of debt interest and welfare payments would push borrowing to “unsustainable levels”, creating a £60 billion-a-year hole in the Budget.
“The burning question is how much would the government need to borrow to cover tax cuts and fund policies?” said Myron Jobson, Senior Personal Finance Analyst at Interactive Investor. He continued;
“Public debt is at the highest levels since the 1960s following the mammoth multi-billion spend on Covid and cost-of-living support measures, and rising interest rates pushing up borrowing costs. The worry is that attempting to square the circle of public borrowing is going to take a significant financial toll on tomorrow’s generation.”
UK businesses and lack of investment
No wonder business confidence is low! A manifestation of all this uncertainty is that businesses are reducing their investment on a deteriorating outlook.
Pound plummets further
As consumer and business confidence plummets, so does the strength of the pound, despite all the interest rate hikes.
As reported in the Telegraph this morning, sterling has fallen to a fresh 37-year low against the US dollar, an unwelcome backdrop to Kwasi Kwarteng’s mini budget today. The pound has fallen below $1.12, the weakest point since 1985, and has now shed 17% against the dollar so far this year. The dollar is seen as a safe haven as one of the world’s most liquid assets at a time of economic and political turmoil.
Kwasi’s cavalry rides into town
Below are the main economic points Kwasi Kwarteng unveiled today:
- The top rate of income tax – the 45% rate for earnings over £150,000 – is being abolished altogether
- He will take the basic rate of income tax down to 19%
The government argue that the tax cuts announced today will eventually pay for themselves because they will unleash higher growth, which means more economic activity, which means tax receipts eventually being higher than they otherwise would have been.
The pound dropped yet further against the dollar on the back of this huge commitment to borrowing.
- The NI hike is to be reversed from November
- Many call this an outdated tax and in this mini budget, stamp duty tax has been cut.
- There will be no stamp duty on the first £250,000 of a property and for first time buyers the threshold will be £425,000
- The planned increase in corporation tax on profits won’t go ahead
Something had to be done!
The mini budget has attracted lots of criticism regarding the wealthy being better off and we understand the rhetoric, but we have to support growth.
From our own business point of view, we welcome the response but there is no doubt that this is a gamble of huge proportions, which in the short-term, may push inflation and interest rates higher.
The austerity experiment after the financial crisis in 2008 didn’t work for the UK. Now we are taking a leaf out of the US’s book and looking to drive growth. As has been shown in many times of crisis, inertia is not a good response!
There are no real hiding places from what is going on across the globe. Each country has its own specific challenges but there is no doubt that the UK was leading the way on many negative metrics.
It’s difficult to imagine what the good times will look like economically, but they will come. The mini budget, on top of the energy cap aid, underlines how quickly things can change. Of course, unlike in the depths of the pandemic, creating inflation is not what it’s all about.
Investment wise, it’s cash and the dollar that are king as confidence deteriorates. Investment markets have not reacted kindly with many UK equity indices falling by circa 2% today over concerns that this is a deep dive into the abyss.
The key concern for equities beyond the immediate horizon though, is not the extent of government borrowing or the size of debt, but corporate earnings. Many elements and factors however are intertwined, and the fear is that Central Banks will have to take interest rates much higher.
Confidence is being battered but like a storm, this won’t go on for ever. It may stay around a bit longer but, eventually, it will blow itself out!
Have a great 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.