Please find below our Investment Market Update as at 25th November 2022.
The engines are being revved on the starting grid
After a year of pain we could be witnessing a turn in fortunes for some of the main equity indices, not forgetting bonds.
Following a softer rhetoric from many quarters, stock markets have been more sanguine than in previous months, helped by the notion that inflation may be nearing its peak and interest rate rises will soon begin to slow. The question being asked is “could this be a good time to enter the markets and/or increase risk”?
Although not a big car man, I did use a couple of driving analogies at our investment meeting this week:
“We have been happy to wait on the hard shoulder (cash) as the traffic was going nowhere but now it is moving (equities), we don’t want to be watching the traffic from a standing position, do we”?
“It feels like we are on the starting grid, revving the engines but not sure whether there is another practice lap, or if the race is going to start for real”.
Apologies for those!
In other words, markets wise, there is a lot more positivity around than a few weeks ago. However, as we know from recent experiences, “expect the unexpected”! But, of course, this doesn’t always have to be of a negative tone.
At Blue Sky we now feel that it is time to deploy circa 50% of our cash holdings in our infrastructure and Sapphire portfolios. With our lower risk portfolios, we will use much of the money to increase our bond holdings and in the higher risk, focused equity holdings. We will however look to retain circa 20% cash across all our in-house portfolios.
Why not all the cash?
It’s called ‘hedging one’s bets’. Whilst sentiment has improved, it will need a significant turnaround in data and a strong positive response from Central Banks to see markets supported into a bull market.
Many analysts suggest that we are close to a short-term peak in the main equity indices, but it is also possible that the indices can break out from its 2022 constraints and surge forward. The chart below prepared by Paul Claireaux on the S&P 500 asks the question ‘what happens next’?
It’s also important to avoid generalisations. Not all equity indices have behaved in the same way. The key is picking the right assets at the right stage of the economic cycle. The financial sector is proving very resilient despite economic recession looking very likely. Rapidly rising interest rates and elevated rates are serving this sector well, as it offers the potential for increased profit margins, despite the backdrop of possible loan defaults. We are introducing a Sustainable Financial Index into all but our most defensive portfolio.
Is it worth holding UK equities?
You could be forgiven for avoiding the UK. I’m not talking about the FTSE 100; I’m talking about stocks which are more of a reflection on what is happening in the UK.
There are not many positive headlines about the UK, but it may be that much of the bad news is already in the price of stocks. The FTSE 250 has risen strongly since the middle of October.
A recent article in the FT highlighted the negative sentiment towards the UK economy. The Organisation for Economic Co-operation and Development (OECD) forecasts that UK GDP will only rise by 0.2% in 2024, the worst projection of all the major economies. The UK is set to be the worst performer in the G20 and is already the only country in the G7 where output has not regained its pre-pandemic levels.
The OECD also hit out at the UK government’s pledge to hold average household energy bills at £2,500 until April, saying the untargeted support would “increase pressures on already high inflation in the short-term”, leading to higher interest rates and debt service costs. The OECD said business sentiment was starting to recover from “a period of deterioration driven by policy uncertainty” — an allusion to the hastily reversed “mini” Budget under former Prime Minister Liz Truss.
The risks to the UK’s already poor outlook were “considerable and tilted to the downside”, the OECD said.
Stocks have bottomed out?
Market commentator, Ed Yardeni believes stocks are in the process of bottoming and the Federal Reserve (Fed) won’t raise rates as high as the Fed Chairman, Powell, has suggested.
This could well be the case and forward guidance often has the desired impact without having to implement the very thing that you have given guidance on!
Despite hawkish comments, Yardeni in his interview with CNBC, as reported in the Business Insider, said “expect other Fed officials to push back on raising interest rates too far”. He feels that stocks have already priced in a 4.75% – 5% interest rate and anything less may bring a positive response from the stock market. Other experts have also made the case for the Fed to ease up on hiking rates. Wharton Professor, Jeremy Siegel, noted that real inflation lags behind the official statistics by some 18 months, which means the Fed risks overtightening.
Analysts from JPMorgan added that inflation was showing signs of being in its final stages which should put less pressure on the Fed to keep raising rates.
JPMorgan forecasts strong returns
JPMorgan, this week, reported that investors should no longer worry about stocks being too expensive. As reported by Trustnet, investors are forecast to make 8.5% a year from global equities for the next decade. JPMorgan state that a tough year means valuations are in the rear-view mirror (must have been on the same investment course as me!).
Vincent Juvyns, global market strategist at JPMorgan Asset Management, said the macro-economic picture was also improving. “Despite near-term cyclical challenges, our inflation forecasts move only modestly higher as we see inflation cooling close to central bank targets”, he said.
He went onto say “expect a greater divergence in performance amongst regions, countries and sectors”. He also stated that investors should consider when they invest, noting that things may get cheaper before rebounding. “While entry points are more attractive than they were a year ago, they could get even more attractive if the cyclical weakness of 2022 extends into 2023, which seems likely”.
But before getting excited…
JPMorgan believe the stock market won’t see a sustained rally until the Fed starts to cut interest rates. They believe that as long as Central Banks raise rates or keep them at current levels, assets will be rangebound with a more pronounced downside risk.
When interest rates are cut this is likely to lead to a new rally and give way to possible new highs.
The bad news is good news!
Rising interest rates are intended to slow down the economy and there are signs that its working in the US, which is good news, although in the main press it will be treated as bad news.
US retailers are bracing for a slower than normal Black Friday according to FT.com. High inflation and a weakening in economic confidence is expected to erode demand. It’s predicted that inflation adjusted seasonal sales may fall for the first time since 2009, according to S&P Global.
US employers are hiring less seasonal workers as inflation is expected to weaken retail sales. According to Indeed, employers posted 8.2% fewer holiday openings than the previous year. Walmart’s expectations are more dramatic, as they only intend to hire 40,000 people this season compared to 150,000 at the same time last year.
This shows that we are moving along the cycle and with fewer job opportunities, those seeking employment will have to temper their expectations around pay which if course is what the Fed wants to see.
“They sneeze and we catch a cold”!
A saying which refers to the relationship between the US and UK and is certainly true in stock market terms.
This phrase is a European import which was used during the Napoleonic wars and originally was said in context of “when France sneezes the whole of Europe catches a cold”.
Let’s hope England don’t catch a cold this evening when they play the USA in the World Cup. I still can’t get into this tournament, but my cousin can!
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.