Weekly Notes

This week has been anything but dull with US midterm elections, US inflation data and UK GDP dominating headlines.

We will start with the US midterms. There was an expectation that we might witness a strong victory for the Republicans, however, the results have been much tighter than expected, with the final results still in the balance. It looks like the Republicans will win control of the House of Representatives, while the race for the Senate is too close to call at this stage. As results begun to filter through on Wednesday US equities sold off heavily, presumably on concerns the Republicans could block much of Biden’s plans by holding the House of Representatives – political gridlock is rarely a good outcome for markets.

By Thursday however any weakness in markets was well and truly reversed, driven by US inflation data that undershot expectations. The headline inflation figure came in at 7.7%, below the expected 7.9% and lower than September’s print of 8.2%. Importantly the month-on-month inflation (and core inflation) also undershot consensus views. The narrative now has quickly shifted to the possibility that inflation has peaked and the impact of higher interest rates are beginning to work. This will mean the US Federal Reserve will be able to slow their pace of future interest rate hikes, with the terminal rate now expected to be lower than 5%.

To say the news was well received by the market would be a huge understatement. Equities, bonds and commodities all joined the party, with the only real loser being the USD, which slumped over 3% versus GBP on Thursday. The S&P 500 index rose over 5.5% on Thursday, with the more tech-heavy Nasdaq index climbing over 7%. This was the best day for US equities since April 2020. UK and European equities also rallied in the afternoon. The more domestically focused UK FTSE 250 index climbed over 3% while the larger cap FTSE 100 index rose over 1%. Sterling strength acted as a headwind for multi-national businesses in the UK. A week ago, GBP/USD was 1.11, at the time of writing it has risen above 1.17. Improvements in the inflation and interest rate landscape was music to bond markets ears, with yields plummeting (prices rising) across the board. The yield on the US 10-year Treasury bond fell over 30bps, marking the second biggest daily drop since March 2009.

The gold price has risen over 5% in the past week, in part driven by the weaker USD. There have been a cohort of investors that saw cryptocurrencies as a digital replacement for gold. However, investors were reminded of the risk with crypto with the likely collapse of FTX – a cryptocurrency exchange. The founder, Sam Bankman-Fried is estimated to have seen his personal wealth fall by $16bn, while investors in the exchange are nursing huge losses. The company was valued at $32bn during the last round of fundraising.

Staying with US data, the initial jobless claims data was higher than expected, which helped support the view that higher interest rates are beginning to have an impact and the US Fed may slow their interest rate hikes. Jobs data will make for interesting reading over the coming weeks, with Meta (facebook) announcing jobs cuts of 11,000 on Wednesday. We also expect employment in construction to fall as higher mortgage rates lead to a slowdown in new residential construction.

UK Q3 GDP data was disappointing, showing the economy contracted from July-September; the only G7 nation so far to report a contraction for Q3. In more bad news for the UK, it is now the only G7 nation where GDP has not recovered to pre-pandemic levels. Despite the disappointing news, the FTSE 250 index was up over 1% on Friday morning, carrying on the rally from Thursday.

Time will tell whether this week’s big moves are the start of a sustained recovery or another bear market rally, like the summer months. While it is pleasing that inflation is showing signs of peaking, we are also mindful that some of the global economic data is beginning to deteriorate and as such it is prudent to maintain asset class, country and currency diversification in portfolios.

Andy Triggs, Head of Investments

Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.

The Month In Markets – October 2022

If the UK was the problem for September, China was the problem child during October, with concerns around the world’s second largest economy dragging down Emerging Market and Asian benchmarks. As investors, the recent country specific woes of the UK and China are evidence as to why we try to diversify portfolio risk not just by asset class and sector, but importantly, also by country.

For those that regularly read these monthly pieces, you may notice that the best performing index from the chart above, ICE BofA Sterling Corporate (UK investment grade bonds), was in fact, the worst performing index in September. UK government bonds, which fell around 10% in September, also rebounded to end October up over 3%. It is a timely reminder about the risks of performance chasing and simply selling losers and buying winners. It also highlights why we think periodic rebalancing of portfolios is important. This process allows for natural profit taking from the better performing assets and allocating proceeds to the laggards within portfolios. The value of rebalancing really kicks in during extreme volatility.

So what caused the reversal in UK bonds? A big part of it was the changing political landscape. We began the month with Liz Truss as Prime Minister and Kwasi Kwarteng as Chancellor, and ended the month with Rishi Sunak as PM and Jeremy Hunt as Chancellor. The new PM and Chancellor appear to be much more focused on balancing the UK books and have ultimately reversed all of the mini-budget tax cuts, hinting that taxes may in fact rise. This more responsible fiscal approach was well received by markets, the result being a fall in borrowing costs for the government and a rebound in GBP, particularly against USD, with sterling strengthening over 3% during October. It is unlikely to be plain sailing for the new PM; the more fiscally responsible path he and Hunt are pursuing is likely to be a headwind for economic growth. Spending cuts and higher taxes will hurt the consumer. The main positive for growth is that with falling borrowing costs we may see mortgage rates begin to come down, and while they will still be considerably higher than in recent years, they should at least be lower than was forecast under Liz Truss’ watch.

As well as a change in UK political risk, there was also likely some mispricing opportunities that enticed investors to allocate to areas such as sterling corporate bonds. Many pension schemes faced solvency issues following on from the mini-budget and had to sell assets in order to raise cash and meet margin calls. Sterling corporate bonds were caught up in the fire sale, and we believe the huge selling pressure created mispricing opportunities for long-term investors. Part of the moves in October will have been driven by buyers stepping in, taking advantage of the forced selling and picking up high quality bonds at multi-year high yields.

While UK and developed markets in general had a positive month, the big laggards were Emerging Markets and Asian equities, which were dragged down by China. Towards the end of the month, it was confirmed that Xi Jingping, leader of the Chinese Communist Party secured a third five-year term, discarding with previous custom in which his predecessor stood down after 10 years. What spooked markets was an apparent change in Xi’s approach from the previous 10 years. In appointing his inner circle, the seven-strong Standing Committee is made up of his close allies, which means Xi will have little push back against any of his policies. These allies have also replaced more market-friendly, open-economy committee members. There is concern that over the next five-year term Xi will be less market friendly in his approach. The Covid-Zero policy is one example of this, or his new focus on “Common Prosperity” – an attempt to redistribute wealth which could lead to more regulation on certain sectors and industries. The Hang Seng Index (Hong Kong) fell over 6% on the news of Xi’s re-appointment, the largest one day fall since 2008, with the index returning to levels seen in April 2009. The Chinese currency also retreated, falling to 14-year lows versus the USD.

There were also immediate concerns about China’s economy, with the country delaying the release of third quarter GDP. The official data was released eight days late, and while it was higher than expected, investors doubted the credibility of the data given the unprecedented delays in it being released.

During the month we had the release of Q3 earnings and there were some interesting trends coming from the US. The mega-cap tech companies such as Microsoft, Meta (facebook), Alphabet (Google) and Amazon all released disappointing results which led to big pull backs in share prices. During the initial COVID-crisis these companies were major beneficiaries, and their share prices did exceptionally well. However, it appears in this more traditional slowdown their business models will not be immune to the headwinds with growth rates and revenues likely to slow.

The month in general had a wide range of dispersion in returns between asset classes and geographical regions. If diversification is not sufficient investors can be caught out by the heightened volatility and country specific risks that we have witnessed in September (UK) and October (China). Our approach of seeking genuine diversification in portfolios should provide a high probability of avoiding the worst outcomes in markets. As we have written about previously, we believe not losing in the short-term leads to winning in the longer-term.

Andy Triggs

Head of Investments, Raymond James, Barbican

Appendix

5-year performance chart

Risk warning: With investing, your capital is at risk. Opinions constitute our judgement as of this date and are subject to change without warning. Past performance is not a reliable indicator of future results. This article is intended for informational purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person.

Halloween came and went on Monday with relative calm; however, it was US Fed Chair Jerome Powell who spooked markets later in the week.

The month of October closed on Monday, and it marked a strong month in assets, rebounding from a very challenging September. In the US the Dow Jones Industrial Average equity index recorded its best month since 1976, up 14%. The broader S&P 500 index rose an impressive 8% in local currency, although for sterling investors, such was the recovery in GBP, the return was closer to 4.5%.

After such a strong October, the focus shifted to US and UK central banks, who met on Wednesday and Thursday respectively. As anticipated, the US increased rates by 0.75%, taking the headline interest rate to 4%. Equities initially reacted favourably, however, during the press conference Powell made a series of hawkish comments, leading markets to believe interest rates would have to rise further still and with-it equities quickly reversed gains to end the day heavily in the red. The news also sent US government bond yields higher, with the two-year bond now yielding over 4.7%.

The Bank of England (BoE) followed suit on Thursday, raising rates by 0.75%, with the headline interest rate now at 3%. It was the largest individual hike since 1992 and interest rates are now at their highest since November 2008. While the US central bank were very hawkish in their language, the BoE struck a much more dovish tone, saying the peak in interest rates in the UK will be lower than what the market has anticipated. The BoE delivered a very gloomy message with their outlook for the UK economy, saying it expects the UK to experience the longest recession on record, with the unemployment rate expected to nearly double by 2025. Markets are forward looking, the news of a potential UK recession was not new news, and the reaction from UK equities has so far been fairly muted. There was however a reaction in currency markets, with GBP shedding around 2% versus the USD on the back of what could begin to be diverging interest rate policy.

Unemployment data from the Eurozone was positive this week, showing the current strength in labour markets is not just confined to the US or UK. Indeed, Greek unemployment, which was nearly 30% in 2014, is now at 11.8%. There was consensus beating unemployment rates from Spain and Italy. It is worth remembering unemployment data is a lagging indicator and it is likely to deteriorate as economies slow. Staying with employment, the once bullet proof technology-focused companies have begun to freeze or indeed cut jobs. Amazon has frozen any corporate hires for the rest of the year, while Apple has frozen hires outside of research and development (R&D). Twitter, which has recently been acquired by Elon Musk, has gone one step further and is expected to begin laying off staff as soon as today. At a national level, the release of US non-farm payroll jobs data this afternoon showed an additional 261,000 jobs had been added to the economy, beating expectations for the seventh straight month. This positive employment data was well received by the markets with US equities opening up over 1%.

It has been a very strong week for Chinese equities, with an estimated $1 trillion added to the value of stocks this week. Rumours of an easing in China’s zero-COVID policy and hopes of softening tensions with the US boosted the market. The prospect of China re-opening lifted commodity prices with copper up over 6% on Friday, while mining companies rose; Anglo American leading the UK large cap index higher today.

The up-and-down week is a reminder of the difficulty of trying to time markets. Our preference instead is to focus on time in the markets. That being said, we have used the recent volatility in bond markets to make changes which we will feel improve the defensive characteristics of the portfolios, while still providing attractive long-term return profiles.

Andy Triggs, Head of Investments

Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.

This week saw the appointment of Rishi Sunak as the leader of the Conservative Party and the first Indian-heritage UK Prime Minister. He is the third UK Prime Minister this year and the fifth in six years; the Conservative party will be keen for some stability to return and put an end to the revolving door at No. 10.

Penny Mordaunt once again declared she would run for the UK’s top seat however the endorsement Mr. Sunak received was so significant that Ms. Mordaunt didn’t stand a chance. Britain is facing an economically toxic combination of high inflation and rising interest rates. Mr. Sunak’s first task was to restore the UK’s financial credibility after previous PM Liz Truss shocked the bond market with plans for unfunded tax cuts and an extended energy price guarantee, forcing the BoE to intervene. Sunak’s focus on financial stability has been well received by markets so far – we have since seen a reversal in government bond yields, with borrowing costs for the UK government now back at pre mini budget levels. We have also seen a recovery in the Sterling, closing Thursday night at $1.16.

Jeremy Hunt has stayed as Chancellor and earlier this week announced he would be delaying the Autumn statement. It was originally due to be published on 31st of October but will now be unveiled on the 17th of November.

This week saw Q3 earnings releases from a range of the mega-cap behemoths in the US. The results have been disappointing, and we have seen big declines in their share prices. Meta (formerly facebook) fell 20% after another quarter of disappointing results. The share price has now fallen around 65% in 12 months, and it is estimated that CEO Mark Zuckerberg’s wealth has declined by a staggering $100 billion over that period. There has also been weakness in Microsoft and Google this week, with results showing their growth rates are slowing. Amazon does not appear immune from the challenging conditions, their results last night were underwhelming, with the share price expected to open 14% down today. Rising costs for these companies, coupled with a weakening outlook for consumers and businesses has impacted consumer and advertising spending.

With the news of weaker earnings and an economic slowdown, this could be a reason that central banks may begin to slow rate hikes. It may be premature to call it a ‘pivot’, but we saw the Bank of Canada hike by 50bps rather than the 75bps expected by markets. The European Central Bank (ECB) did hike rates by 75bps, but Christine Lagarde, President of the ECB, spoke at a press conference after the interest rate hike and appeared very dovish, giving investors confidence a pause in their hiking cycle could be round the corner. Investors have now set alarms for the next US Fed meeting next week. While a 75bps hike is almost guaranteed, weaker economic data may allow the Fed to begin to slow, or even pause the hiking cycle going forward.

We can conclude this weekly once again discussing Twitter – Elon Musk has completed his takeover of the social media platform. He has begun his reign with ruthless efficiency, firing many top executives claiming, ‘the bird is freed’. The CEO of Tesla has outlined his plans for Twitter as a free speech platform but preventing hate and division, this includes scraping permanent bans on users. An innovation that Twitter could also see is it becoming a “super app”, this offers everything from money transfers to shopping.

Markets may continue to be choppy given the uncertainty in the global economy. However, there is long term value appearing in asset classes, while bond markets have stabilised. Government bonds, once a sleepy asset class, are now offering yields we have not seen for 15 years. As Michael Gove returned to government this week, he joked that after months of turbulence “boring is back” – let’s hope the same is true for government bond markets!

Nathan Amaning, Investment Analyst

Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.

It has been somewhat of a rollercoaster ride in markets this week with numerous economic data releases from the UK and US, Chinese whispers around UK parliament on the future of the mini budget and historic equity intra-day reversals.

The UK has certainly been the topic of conversation for all the wrong reasons over the period since Liz Truss became Prime Minister in early September. However, there was some good news in the form of jobs data on Tuesday with the unemployment rate falling to 3.5%, beating forecasts. This was the lowest unemployment rate since February 1974, however, there has been a sharp rise in the number of “economically inactive” workers – not employed or looking for work.

We saw the results of UK GDP on Wednesday; GDP month-on-month came in at -0.3% whilst year-on-year came in below expectations at 2% (forecast 2.4%). Growth within the UK’s economy is set to continue to slow as surging inflation continues to hit households, and the Bank Of England (BoE) looks set to continue to raise interest rates sharply in response. The BoE also spoke earlier this week, being very clear that the gilt-buying programme was set to stop this Friday. This sent the pound plunging to $1.10 and gave liability driven investment managers three days to shore up enough cash reserves for pension fund clients to meet margin calls.

There has since been a rally in UK markets as rumours began to spread of Chancellor Kwasi Kwarteng and Prime Minister Liz Truss considering a total U-turn of the tax cuts within the mini budget. The pound traded above $1.13 against USD on Friday’s opening. Last week they reversed their intended plan of cutting the tax rate of 45% to 40% and it’s been reported that a reversal of more of the mini budget will calm market turbulence.  Mr Kwarteng has cut short his visit to the US which could confirm the rumours, it’s worth keeping an eye out on this!

US September inflation numbers were announced yesterday. Inflation YoY came in slightly ahead of expectations at 8.2% versus 8.1%. Core inflation, which excludes food and energy prices came in at 6.6% versus 6.5%. Initially markets fell on the data, but we saw a dramatic recovery into closing. The S&P 500 closed in excess of 2% up, having been down over 2% at the start of the day. This is only the fifth time in history such an event has happened. US government bond yields rose on the inflation news, with markets believing the US Fed will continue to raise rates in an effort to bring down persistently high inflation. The headline yield on the 10-yr US Treasury bond breached 4% – the highest yield since 2009. While it currently feels like one way traffic in bond markets, the yields now available for investors are looking very attractive.

Switching focus to Europe, France has been at a standstill with a week-long strike. French unions walked away from wage talks with oil major Total, dashing hopes for an end to the standoff that has disrupted everyday life in France with petrol stations running dry. Unions have set a bar chasing a 10% wage rise, citing inflation and windfall profits made by the company from the energy crisis. The French Government has since stepped in urging Total to hike salaries accordingly.

This paragraph echoes messages from previous weekly roundups, with a reminder that we continue to focus on being long-term investors and aiming to seek balance and diversification within portfolios. As we have seen this week, anything can happen in markets in a matter of hours or days. However, we expect fundamentals to be the main driver of markets in the long run and by focusing on this we can take advantage of short-term moments.

At the time of writing, it’s just been announced that Prime Minister Liz Truss will be holding a press conference this afternoon, however Chancellor Kwasi Kwarteng will not be present.

Nathan Amaning, Investment Analyst

Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.

The week began with Chancellor Kwasi Kwarteng announcing the reversal of his proposed scrap of the 45% tax bracket. This came only 10 days after it was first unveiled in the mini budget. It is anyone’s guess if this will be the only reversal of the mini budget – the Chancellor and Prime Minister remain under intense pressure following the mini budget and subsequent market reaction.  

After much scrutiny within his own Conservative Party and triggering turmoil in financial markets, Chancellor Kwasi Kwarteng is set to bring forward the publication of his medium-term fiscal policy. There were significant concerns that the original publication would not be available until 23rd November; it is hoped that an early fiscal statement will help calm the markets and “reduce the upward pressure on interest rates”.

After 225 days since Russia invaded Ukraine, President Zelensky announced a surprise bid for fast-track membership to join NATO. He has recently ruled out talks with Russia’s President Putin after Moscow claimed to have annexed four Ukrainian regions. Zelensky appears intent on showing that Putin is failing in one of his main war goals- preventing Ukraine joining NATO. Ukraine is certainly looking to the future and restabilizing their country and economy, announcing they have joined Spain and Portugal in a joint bid to host the 2030 football World Cup. Hosting such a major sports event would help to boost Ukraine’s construction and tourism sectors. It is estimated the 2022 World Cup in November will bank Qatar $20 billion. The Olympic Stadium in Kyiv most recently hosted the final of the 2018 Champions League.

US Jobless Claims data yesterday was a little worse than expected with 219k claims against a projected 203k. This is a measure of new applications for unemployment benefits and the rise in claims is the latest sign of a cooling labour market, something the US Fed will be keeping close eyes on. Staying with the US the equity market started the new quarter with a bang, with significant gains on Monday and Tuesday. This was the best two-day period for US equities since April 2020 and also the best start to a quarter since 1938. The rally in equities coincided with falling government bond yields in the US and a weakening USD. Sterling rose above $1.13 at the start of the week, although gave back some of the gains by Friday.

US Non-Farm Payroll numbers were released this afternoon with 263k jobs added against a forecasted 250k. This is below the 350k jobs created last month and the least since April 2021 (although still a healthy number). The immediate market reaction was for bonds and equities to sell-off, most likely on the view that this jobs data will do little to deter the US Federal Reserve from raising interest rates further.

We aim to end this weekly round-up on a light-hearted note and what better way than to discuss Elon Musk’s Twitter bid being back on. Performing “U-turns” must be a buzzword at this point, as Elon Musk revived his bid for the social media platform, with the hope the proposal will eliminate the pending court trial later this month. Banks funding a large portion of Mr Musk’s $44 billion deal could be facing significant losses. Investors have certainly lost the appetite for leveraged loans as riskier debt does not go hand in hand in the current market environment of rapid interest rate hikes.

The continued volatility in bond and equity markets can be uncomfortable, but as we have often highlighted, it can also create opportunities, particularly for long-term investors. Markets are forward looking and it’s important not to get too distracted by the short-term noise, instead focusing on where asset prices could be over the coming years.

Nathan Amaning, Investment Analyst

Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.

The Month In Markets – September

September was an extremely difficult month for markets, with most asset classes witnessing sharp falls in value. The continuing story around inflation and interest rates was partly to blame, while the UK had additional pressures created by the mini-budget. 

One of the major headwinds for global assets during the month was higher than expected inflation data from the US. This has been a recurring issue for equities and bonds in 2022. Higher inflation leads to investors then pricing in higher interest rates which will be required to combat inflation, and this had negative implications for both equities and bonds.

US headline inflation came in at 8.3% for August, marginally ahead of expectations of 8.1%. However, it was the core month-on-month inflation that really spooked markets. Core inflation strips out highly volatile items such as food and energy and this accelerated by 0.6% month-on-month. This is one of the US Fed’s preferred inflation measures and led markets to immediately price in higher interest rates ahead, with the expectation that the US Fed funds rate would be 4.6% at the end of 2022.

The reaction to the inflation data was felt immediately, with US equities falling over 4%, suffering their worst individual trading day since 2020. We also saw yields on US government bonds rise sharply (prices fall).

Digging a little deeper into the data it was the shelter/rents component that was one of the biggest drivers behind the inflation data. The initial impact of higher interest rates may mean it is harder for first time buyers to get on the property ladder, which could lead to greater demand for rental properties and push rents even higher!

While US inflation data was a headwind for markets, the UK mini budget caused extreme volatility in UK bonds and currency markets. You will notice from the chart that both UK gilts (government bonds) and UK sterling corporate bonds suffered significant drawdowns in the month. These moves are far from normal, and the price action witnessed in UK government bonds has been described as a once-in-a-generation type event.

The mini budget shocked markets with much greater unfunded tax cuts than anticipated. There were two big problems with this – a huge increase in debt issuance and increasing budget deficits made the UK less creditworthy, while the tax cuts could lead to increased consumer spending and higher inflation, and therefore may warrant even higher interest rates. This was enough to send both UK government bonds and Sterling nosediving. Within 24 hours of the mini budget we witnessed sterling hit an all-time low of $1.035 against the USD (it should be noted that from here were have seen something of a mini-recovery in sterling). As the sell-off in government bonds continued, many liability-driven investment (LDI) pension funds ran into trouble. There came a breaking point where the Bank of England had to step in and provide support to the bond market, announcing they would buy an unlimited amount of long-dated UK government bonds for a finite period of time. The news was enough to reverse some of the pain that had been felt and led to a significant relief rally. Sterling corporate bonds were caught up in the mayhem, in part as they derive some of their price from government bond yields, but also because in a scramble for liquidity many LDI schemes became forced sellers of these bonds in order to meet cash calls.

The dramatic rise in government bond yields in the UK caused issues in the mortgage market. On the 27^th September almost 300 mortgage deals were pulled from the market, and we have since witnessed a large increase in borrowing costs for homebuyers. Any benefits of the tax cuts for consumers will likely be wiped off in much higher mortgage payments going forward. With a deteriorating outlook for the UK consumer, domestically facing UK equities suffered the brunt of the pain.

Asset-class diversification in September was very limited, with most bond and equity markets falling. One respite came from a weakening sterling, which benefits sterling investors holding foreign assets. Within portfolios we have been increasing exposure to currencies such as the USD this year and that has been a positive contributor.

While undoubtedly difficult at the moment, the price movements we are seeing are creating longer-term opportunities. Within fixed income markets for example, we can now receive yield to maturities in excess of 4% for lending to the UK or US governments, even in shorter-maturity bonds, which typically carry much less interest rate risk. Two years ago, this yield on shorter maturity government bonds was closer to 0%.

Andy Triggs

Head of Investments, Raymond James, Barbican

Appendix

5-year performance chart