Welcome to our quarterly investment overview
Quarterly update on economies and markets.
The journey of inflation and interest rates has undoubtedly been prolonged and in many ways, the graph of the FTSE 100 over the last six months is a window to the uncertainty which has been prevalent. At the start of this week, we experienced a mini bounce with the European markets posting their biggest one-day rise for eleven months on improved sentiment about US interest rates. In the UK, the governor of the Bank of England (BoE) stated that we have only seen approximately one-third of the impact of elevated interest rates meaning the majority is yet to be seen. A confusing picture for sure, but there are signs of improving sentiment.
I started off the week by attending the launch of the Dorset Business Festival at Rick Stein’s at Sandbanks and was then privileged to be a panel guest for the conference on Tuesday hosted by the Dorset Chamber. I was a contributor to the talk on how businesses need to integrate ESG into their strategies. All went well and I have to say, it made me proud to be associated with the dynamic business community we see in Dorset. The main guest speaker was David Smith the Economics Editor at the Sunday Times. His views on the UK economy I will share later in this script.
As a result of all these touchpoints, I thought this quarterly update should be slightly different than the usual format, although we will still include comments from our investment partners. We will also include the views of the investment company, Vanguard.
Turmoil in markets
The graph below of the FTSE 100 below, courtesy of ft.com, highlights how volatile markets have been with much of the volatility being down to the varying expectations around the economy, inflation, and interest rates. The FTSE 100 being a concentrated index with a global focus is not truly reflective of the UK economy, but it does highlight the yo-yoing of sentiment, even if latterly, higher oil prices have helped the index in its recent rise.
European markets post their biggest rise for eleven months
European stocks on Tuesday notched their biggest daily gain in 11 months, as a rally in US Treasuries and unconfirmed reports of fresh Chinese stimulus measures, boosted markets.
The Europe Stoxx 600 closed 2 % higher, its biggest rise since November 2022, Bloomberg data showed. Travel and leisure stocks rebounded, having sold off sharply on Monday on concerns over the conflict between Israel and Hamas.
London’s FTSE 100 added 1.8 % with mining groups among the best-performing stocks as investors seized on rumours that China is considering raising its budget deficit to bolster its ailing economy.
On the flip side, gas price futures in Europe have risen due to the conflict between Israel and Hamas. According to ft.com, Dutch gas prices have risen by 32% since markets closed last Friday, 6th of October. These price moves come as supply constraints emerge in global markets. Israel cut its production of its gas exports to Egypt, not helping was also the suspected sabotage of a Baltic sea pipeline between Finland and Estonia and ongoing strikes by gas workers at Chevron’s liquified natural gas facilities in Australia.
Such rises aren’t helpful in the fight against inflation but at the same time, they are likely to dampen economic growth.
US markets boosted
According to Federal Reserve officials in the minutes of their September meeting, monetary policy is likely to remain restrictive for some time, but they also noted that risks have become more “two-sided”. In other words, there is a danger that overtightening, and causing a recession, needs to be balanced out against fighting inflation.
US Treasuries (similar to UK gilts) rallied following weeks of declining prices.
It was interesting to note during the week that PepsiCo upgraded its profit outlook despite increasingly weaker consumer confidence. Higher prices have been passed onto consumers which means that despite weaker sales volume and a more selective customer base, the brand remains strong, and profits are expected to increase. An occurrence which is prevalent across many businesses which again can cause confusion in trying to fathom out what’s happening. Weaker sentiment and better profits don’t appear to be natural bedfellows!
Despite the optimism about US interest rates remaining on hold at the next Federal Reserve meeting, data released only yesterday, dampened sentiment as US inflation remained at 3.7%, higher than was forecast.
What did David Smith say?
Every shock has consequences and we’ve certainly had a series of shocks across the globe, with the UK having had its fair share. We have to accept that the UK has been in a period of slower annualised growth now for over a decade. UK productivity was 2% annualised from 1990 through to 2010, however, since 2010 annual growth has only been 0.6%. Net debt as a percentage of GDP is currently at levels last seen in the early 1960s and we have the highest tax burden we have seen since the 1940s, mainly due to income tax thresholds and corporation tax levies. Not good on the face of it!
He then commented about the global economy and reinforced that across the globe, economic growth is subdued, with Gross Domestic Product (GDP) coming in at 4%. The main reasons being: –
- Huge energy price shocks
- Labour shortages
- Supply chain
- Central Banks tightening policy resulting in an increased cost of borrowing
He then moved on to focus on how higher interest rates are starting to work.
David highlighted that there has been a drop in job vacancies here in the UK and the unemployment rate is rising. Perhaps the medicine is starting to work!
At the same time according to the GFK consumer confidence barometer, things are improving, and we have moved off the lows of last winter when consumer confidence was at its worst.
As inflation falls, he reminded the audience that this will manifest in a real boost to household incomes. He also stated that we shouldn’t underestimate that there is a huge avalanche of savings sitting on the sidelines, waiting to be spent.
Furthermore, 60% of mortgages are currently fixed for 5 years which means only a minority of households will feel the effect of higher interest rates.
He said it was “touch and go” as to whether we have a recession, but he was convinced we are heading for a period of strong growth. One shouldn’t be alarmed if the headlines scream recession, this is the best time for potential investors.
He did comment on how markets had responded positively back in February when it looked like inflation had peaked, only to be disappointed, yet again. He strongly suggested that we shouldn’t get hung up on the rhetoric “higher for longer” for the following reasons: –
- We aren’t seeing a full-blown wage-price spiral
- Energy price spikes don’t tend to last
- Quantitative easing is now over
- Producer price inflation is now negative
- Interest rate rises always lag inflation
On Wednesday reports from KPMG and the Recruitment and Employment Confederation (REC)’s findings, show permanent positions fell again in September with companies reluctant to commit to such hires. The rate of decline was, however, the weakest it has been in three months.
Pay pressures continued to weaken last month with rates of starting salary inflation and temporary wage growth edging down to 30- and 31-month lows respectively, according to the UK Report on Jobs survey, which was compiled by S&P Global.
Jack Kennedy, Senior Economist at Indeed, told Express.co.uk the latest figures will bring some relief to the BoE.
He said: “The Bank of England are likely to take some comfort from the latest survey findings, as they suggest wage pressures may be set to cool while recruitment activity was stabilising in September”.
LGT Wealth’s views
“Economic growth surpassed expectations throughout the quarter, despite the Federal Reserve’s efforts to cool the economy with its aggressive rate hiking cycle. As such, prospects of rate cuts moved further into the future.” Sanjay Rijhsinghani, Chief Investment Officer.
Both the Fed and BoE delivered a rapid series of rate hikes to bring their respective rates to over 5%. Economic resilience has surprised them, but interest rates have now reached levels to put sufficient pressure on the economy and dampen inflation. Interest rates will remain higher for longer until growth and inflation show significant signs of cooling. Rising borrowing costs mean businesses with strong balance sheets should be in a better position to weather a potential downturn. We continue our selective approach of quality companies that display long-term compounding of earnings.
Not something we’ve seen too much of in the latter part of the year, but LGT believe there are significant reasons to be optimistic. Equity valuations in the region trade at a significant discount to US equities and recent data suggest the Chinese economy may have bottomed during the quarter. It is probable that Chinese authorities’ recent stimulatory actions in reducing interest rates, help with childcare and the elderly, and a cut in stamp duty for stock trades amongst others, have not yet filtered through to the economy. As such, we expect growth to pick up in the coming quarter.
Legal and General Investment Management views (LGIM)
I spoke to Andrzej Pioch at Legal and General, and he highlighted how mindful they were of what may unfold in 2024 which picks up on what Andrew Bailey stated this week that two-thirds of the impact of rate rises have yet to be seen.
Despite general market sentiment being positive LGIM aren’t positive on UK gilts or US Treasuries and instead they see more compelling opportunities in regional countries. They like Emerging Market Debt, and we have exposure to this via their dynamic bond.
On the equity front, they see value over the long term in the Far East and Emerging Markets, particularly frontier markets like Vietnam. They also like commodities. Interestingly, they also are interested in Real Estate Investment Trusts (REITS) and infrastructure, at such discounted price levels.
They still have recession as their base case suggesting a 30-40% chance of this happening.
Their key points with their quarterly overview are as follows: –
- US inflation data to exceed expectations which came true this week!
- The European Central Bank won’t now increase interest rates.
- UK policymakers faced with strong inflation and wage growth, rising unemployment, and falling economic output.
- Tentative signs that China’s economy is beginning to recover.
In the US they maintain their view of a 1.8% growth forecast for 2023 and their base case is for a recession within the next 18 months. As for the UK, they also believe there will be a recession in the next 18 months with GDP unchanged from 2022. With regards to the Eurozone, they are expecting rapid disinflation and hence their views about them having reached the peak of the interest rate cycle. They expect core inflation to end the year at around 3.3%. By contrast, they expect China’s economy to achieve GDP for 2023 from 5.25% to 5.75%.
There is clearly a lot of uncertainty and the sudden lurches and rises across markets, reinforce a lack of sustainable conviction by investors. There is a lot of cash on the sidelines waiting to be invested at the right time.
In the last 5 days we have seen the FTSE 100 rise by 2.59%, the FTSE 250 by 1.34%, the Eurostoxx 600 by 2.6%, the S&P 500 by 3.53% and the Nasdaq by 4.41%, albeit it is still down for the rolling month by circa 0.5% as of 17.30 on 12th October. Reinforcing the improved sentiment in China and the Far East, the Hang Seng has risen by 5%.
As I have commented many times, the investment markets are a forward-looking indicator of what’s to come and with base cases suggesting a recession, then it’s no surprise that there is some hesitation and lack of real conviction. However, as David Smith from the Sunday Times stated, a recession is not to be feared it’s the point of opportunity.
Areas like commodities, India, frontier markets and some emerging economies look really attractive, price-wise. Across the developed world the picture is mixed but as we saw with PepsiCo, good news and bad news are making this a complicated picture. Many analysts have been wrongfooted this year as economic growth has proved more resilient than expected, but the flip side is ‘higher for longer, message. As David Smith stated perhaps, we shouldn’t worry about this because the popular rhetoric has been wrong before and events can change quickly.
Our belief is that there are some terrific opportunities but there are pitfalls along the way. We believe in a well-balanced portfolio investing in strong companies with robust balance sheets but we also like the value other areas of the world are presenting, at the moment. Diversification is key.
I’m off to the Dorset Business Festival awards dinner with some members of my team as I write on Thursday, late afternoon. No, we are not hoping for an award but instead, I’m presenting the environmental impact award.
Have a good 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.