​Investment Update — October 2022

Financial markets took fright at the scope and scale of the Chancellor’s mini-budget last week. Tax cuts (£45bn) on top of the energy price cap (£60bn), a lack of clarity around spending cuts, the absence of independent analysis by the OBR, abolishing the 45p higher rate of tax and removing the cap on banker’s bonuses, all during the current cost-of-living crisis.

From an economic perspective, we now have the prospect of monetary policy working directly against fiscal policy. The Bank of England is trying to control inflation by raising interest rates, even if it means a prolonged recession, whereas the government want to stimulate growth.

Sentiment remains weak and everyone is seemingly underweight equities. That is why we’re seeing extreme daily moves – the S&P 500 enjoyed its strongest two-day performance since 2020 earlier this week. In a bear market, and after a month like September, it’s perfectly normal to see markets enjoy a sharp rally from oversold conditions, but it’s unlikely to be sustainable until some of the major macroeconomic headwinds begin to subside.

Central banks have long accepted that a global recession is the price to pay to bring inflation down. Short of a major global financial crisis, the Fed and other major central banks will continue raising rates until it’s evident that the global economy has buckled. That says to us that there may be more volatility to come for equites, but bonds are steadily becoming more attractive.

The UK faces an uncomfortable mix of political and economic uncertainty in the coming months. It is unlikely that the Bank of England will raise interest rates to 6% because it would trigger a housing market collapse and a severe recession, but they will continue to cautiously raise interest rates in-line with other central banks. On any meaningful timeframe, UK government bonds are starting to look attractive, and UK equities, already trading at a huge discount to global equities, are now even cheaper. Like the UK, European countries are also embarking on a fiscal splurge in order to protect households from rising energy prices, and they also have a central bank intent on raising rates despite a weak growth outlook.

However, let’s not forget that a lot of bad news has already been priced in by financial markets. Equity valuations in the UK and Europe are at 2008 levels, as is consumer sentiment. If we look forward 6 months the world could look quite different.

Positive news can come in the form of a less severe energy crisis in Europe than expected, especially if we have a mild winter, and developments in relation to the war given Russia’s precarious military position. We also had a central bank bucking the trend on Tuesday, when the Reserve Bank of Australia surprised markets by only raising rates 0.25%, despite market expectations of a 0.50% hike. They cited rising uncertainty over the global economic outlook, the substantial increase in rates in a short space of time, and the impact of higher mortgage rates on households. We may begin to hear a similar tone from other central banks early next year.

Written by:
Charlie Lloyd
Head of Investment, Skerritt