‘’Any contrarian knows that a grim present is usually a precursor to a better future’’ – Seth Klarman. The many events that have taken place this week have certainly left a grey feeling, however, the volatility will also have potentially created investment opportunities for long-term, contrarian investors.
We start this weekly round-up addressing the elephant in the room; what has gone wrong in UK markets? Last Friday, Chancellor Kwasi Kwarteng announced a mini budget which included several tax cuts and policy reversals. He told MP’s that he intended to scrap the tax hikes previously announced by defeated Tory leadership contender Rishi Sunak, as well as controversially lowering the top income-tax rate from 45% to 40%. The total cost of this mini budget totalled £45 billion (excluding the energy cap); with assurances the money would come from the economic growth that would be generated from the tax cuts. Investors were not so sure and talks of unfunded tax cuts unsettled the markets and triggered a run on the pound, which saw sterling fall to a record low of $1.03 by Monday morning.
Stock markets responded to this with a sale of UK shares, with the FTSE 100 falling to its lowest level this year, domestic stocks bearing the brunt of the pain. The moves in equities were nothing compared to what happened in bond markets this week. It is not an exaggeration to say the behaviour of the UK gilt (government bond) market was unprecedented and something that no investor has experienced before. The UK’s 30-year gilt yield rose to 5% on Tuesday, its highest level since 2002. By Wednesday the situation was so dire that emergency intervention from the Bank of England (BoE) was required, who once again has become a buyer of UK gilts. This was seen as an essential intervention from the BoE as rising yields triggered a run-on pension funds. The intervention had an immediate effect, with a steep drop in yields on Wednesday. The volatility was so extreme that one long-dated UK inflation linked government bond rallied 124% on Wednesday alone!
Due to the volatility, it has made it difficult for banks and building societies to price mortgages and we have seen a meaningful amount of mortgage products withdrawn from the market. The mortgages that remain for homebuyers now have much higher interest rates than anytime over the last five years. This will have implications for the housing market and the UK consumer. Last week we said that the mini budget would either be bonkers or brilliant, we may already have our verdict.
US markets have seen significant volatility this week as continued hawkish commentary from the US Fed has led investors to believe their fight against inflation could send the US economy into recession. The Nasdaq sank to its lowest level of 2022 as the tech heavyweights such as Apple and Nvidia slumped more than 4%. The S&P 500 touched lows last seen in November 2020, coincidently the same time as Biden’s election victory. US employment data remains robust with the number of Americans filling for unemployment benefits falling to a 5-month low, as their labour market remains resilient despite the aggressive interest rate hikes.
Airlines were forced to cancel almost 2,000 US flights on Thursday as Hurricane Ian hit Florida’s Gulf Coast in one of the most powerful US storms in recent years. Florida is a major part of the US aviation sector as some companies such as JetBlue Airways and Southwest Arline’s typically see 40% of their daily flights land at a Florida airport.
PepsiCo have announced they have stopped making drinks such as Pepsi, 7UP and Mountain Dew in Russia following President Putin’s mobilisation call last week. It seems Putin has not given up in his pursuit of Ukraine as he called for four regions of Ukraine – Donetsk, Luhansk, Zaporizhzhia and Kherson – to be formally annexed. The US have said they will impose further sanctions on Russia because of the staged referendums that took place to annex the cities, while the EU member states are considering an eighth round of sanctions.
There were further developments this week with European gas, with explosions reported on the Nord Stream gas pipelines. Currently there seems to be genuine confusion around who is to blame for this likely sabotage, with the rumour mill and conspiracy theories in full throttle.
By the end of the week there had been a bit of calm restored to markets. Indeed, sterling has recovered from the lows at the start of the week ($1.03 vs USD) to around $1.10 at the time of writing. Longer-dated gilt yields have also fallen significantly from Tuesday’s highs.
The calm in markets on Friday was unlikely to be felt by the new UK Prime Minister, with a survey from YouGov showing a monumental collapse in support for the Conservative Party. The YouGov poll showed that at the current time Labour would walk a general election with a staggering 498 seats, while the tory party would lose 304 seats, winning only 61. The news will no doubt increase the internal pressure the Prime Minister is facing after only three weeks in the job.
This has been a very challenging week for investors. Continued weakness in most major asset classes have meant it has been difficult to shelter from the storm in markets. Sticking to a process and avoiding knee-jerk reactions is critical at times like this. We have seen large falls, followed by large recoveries in both the GBP and UK gilts market this week. The risk is that initial, emotional reactions mean investors are not able to participate in the recovery.
Andy Triggs, Head of Investments & 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 investor