22 Dec MARKET UPDATE FROM SJP’S RORY MARCHANT
For much of the past year, the big economic story affecting markets has remained the same: inflation is too high, and central banks have been increasing interest rates to try and control it. During this time, the central interest rate in the UK has jumped from 0.1% to 5.25%, at the time of writing, with US and Eurozone central banks following a similar pattern. Traditionally, raising interest rates brings down inflation by slowing spending. Higher interest rates make it more expensive to borrow, which can encourage saving and slow down company investments. With the economy slowing, the theory goes, inflationary pressure should naturally ease. The trade-off is that if the economy slows by too much, Central Banks could push an economy into a recession.
Inflation has generally come down since the interest rates have risen, but they remain above the 2% target of most banks. With inflation coming down, several Central Bank decision makers from the US, EU and UK began making noises that interest rates might be approaching their high point. This could have implications for fixed income investments. Yields typically fall once Central Banks stop increasing interest rates. If we’re now reaching so called ‘peak rates’, the question is what comes next? Are we looking at a relatively rapid fall back to a low-rate environment, or will they plateau, staying relatively stable for some time?
Part of the issue central bankers are facing is that the US economy is actually performing quite well. Spending remains relatively healthy and, while it has weakened a bit, job data remains positive. The US is expected to achieve the vaunted ‘soft-landing’ that was hoped. From an investors point of view, this strength means central bankers will feel more comfortable keeping rates higher for longer – which is consistent with the messaging we’re hearing.
This has even dampened the performance of the so called ‘mega’ tech companies, such as Apple and Nvidia. They really drove equity performance in the first half of the year; however, the picture wasn’t quite so straightforward in Q3. For example, Apple dipped notably as the quarter progressed. Performance was also hurt by softer sales, as well as widespread reports that its new iPhone Pro’s were regularly overheating. The likes of Amazon, Microsoft and even Nvidia – this year’s stock market darling – all saw values recede over the course of September. A critical reminder that share prices can move in both directions.
While in many ways we remain in a similar situation to where we were five months ago with high inflation and rising interest rates, beneath these headlines the situation is changing. The debates around how long rates will need to stay high, climbing fuel prices and the increasing likelihood of a recession in a major European economy continue to develop, and could well play in important role in how investments perform going into next year:
After the risk-off mood in October, world markets have staged a strong recovery in November, as investors increased their bets that the major central banks have ended their lengthy run of interest rate hikes. Markets meandered ahead of the much-anticipated news on US consumer prices. World stocks leapt as a drop in petrol prices helped to drive US inflation to its lowest rate since July. Prices increased at an annual rate of 3.2%, down from 3.7% in October. Housing costs, which include rent, hotel rates and house insurance, remain a trouble spot, climbing 6.7% over the last 12 months (at the time of writing). But overall price pressures were milder than analysts had predicted, adding to hopes that the country’s fight against inflation is nearly over:
Expectations that the US Federal Reserve is done with hiking interest were strengthened as data showed US retail sales fell for the first time in seven months in October. However, the drop was less than expected and followed three straight months of hefty gains. US producer prices also saw their biggest decline in three and a half years, adding to signs of a cooling US economy, although there is no sign yet that it is sliding into recession. Investors are now expected to turn their attention to when the Fed might start to cut rates. Analysts pointed out that in the soft landing for the US economy in 1994-1995, the pause only lasted five months before rates started to come down. US interest rates have been on hold since July.
Markets have also recently been boosted by more positive news on China’s economy. Retail sales grew by a better-than-expected 7.6% in October, and industrial output also picked up faster than predicted. There was also good news on UK inflation, which fell sharply in October to its lowest rate in two years. Consumer prices rose at an annual rate of 4.6%, down from 6.7%. Inflation readings in Italy and France also receded to an annual rate of 1.8% and 4.5% respectively. However, the headwinds created by high inflation and record high interest rates have taken their toll on the eurozone economy. The European Union’s statistics office confirmed its estimate that the eurozone economy shrank marginally in the third quarter, underlining expectations of a technical recession if the final quarter turns out equally weak. Yet employment rose in the quarter – an unusual trend for a weakening economy. Despite the likelihood of recession, a Reuters poll of economists forecast that the European Central Bank’s first interest rate cut will have to wait until July next year.
Without doubt, the road immediately ahead looks difficult. However, right now, plenty of good-quality companies are seeing their values suppressed by wider market forces. We are confident our fund managers are well placed to identify these companies, take advantage of the more reasonable prices, and deliver better returns. Even if the coming months continue to be difficult, by making sensible decisions now, we can make sure we’re set up for long-term success.