October Investment Summary
October was a pleasant change in market performance for risk assets. After large and painful falls in equity prices in August and September, markets bounced back sharply. In US Dollar terms the S&P rose 8%, Nasdaq 3.9%, Euro Stoxx 50 10.1%, FTSE 100 6.1% and the Nikkei 225 rose 3.6%. The Shanghai Composite broke this trend with a 6.7% fall, driven by disappointing export figures and Beijing’s continued ‘Zero COVID’ policy which has hampered economic growth.
Pound Sterling recovered on the back of Liz Truss’s resignation and the reversal of her ill thought out tax cuts, which somewhat watered-down returns on the month. It is possible that Sterling is now in a period of recovery but it is too early to be certain.
Inflation showed signs of slowing down in the US. Headline inflation slowed to 7.7% and the closely watched core inflation measure slowed to 6.3% year on year. If this trend continues over the next couple of months the Federal Reserve may pause rate hikes and keep rates steady at between 4-5% and rely on the shrinking of their balance sheet to further tighten monetary conditions. This is a best-case scenario. Inflation remains far above the 2% target desired by the US, UK and European central banks and there is no guarantee that inflation will continue to moderate to the degree the central banks would like without further interest rate hikes.
Whilst politicians would have us believe that the main contributor in the rise in inflation is the conflict in Ukraine, the chart above clearly shows a pick-up in spring 2021, a full year before the outbreak of war.
Inflation remains uncomfortably high, and still doesn’t look to be weakening significantly as the labour markets in the Western world remains tight which is putting further upward pressure on wages. To add further pressure the oil and gas markets continue to have limited spare capacity due to over a decade of under investment in infrastructure.
There is a grudging realisation that perhaps the continuation and increase of asset purchases with super easy monetary policy combined with massive fiscal transfers during the pandemic created the inflation we now face. The war just exacerbated it.
Monetary policy is not yet tight, and it is likely we find ourselves next year with official interest rates between 3-5%. It will depend on how determined central banks are to return inflation back to 2% for them to hike even more. Let’s not forget that central bank balance sheets are no longer growing. The Fed’s balance sheet is shrinking by $95 billion a month, the BOE is about to begin shrinking theirs with the ECB contemplating similar. This is a very different investment backdrop to the past ten years, where the developed world enjoyed low or even negative interest rates combined with trillions of dollars of asset purchases. The disappearance of this environment is causing sharp adjustments to risk assets that are not yet complete. The recent tumult in the crypto market is more evidence that price adjustments are ongoing.
We expect the investment environment will remain challenging. We will continue our focus on owning quality companies with earnings and pricing power. We still favour energy and commodity industries and health care. We still have an emphasis on value rather than growth. It is possible the worst is behind us but we will not be returning to the heady markets of the past few years any time soon.
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