September Investment Summary
Markets continued their bearish trend in September, with the S&P500 posting its worst monthly decline since March 2020, when the developed world implemented COVID isolation protocols. The major world equity markets in local currency fell across the board. S&P 500 -9.1%, Nasdaq -10.5%, EuroStoxx 50 -5.7%, Nikkei 225 -7.7%, Shanghai Composite -5.5%, FTSE 100 -5.4%.
Global fixed income markets were no help, in fact one might suggest that the dramatic sell off in fixed income (prices fell and yields rose) encouraged the stock market rout. Most developed countries experienced sizeable yield rises on their ten year government bonds.
This is not the first time this year that both bonds and equities have declined in tandem, but it is certainly the worst we have seen in 2022. The question on every market participants mind is ‘how long will it continue.’ The problem remains that inflation is still too high and shows little sign of slowing. Central banks around the world continue raising rates at above average levels, with the US Federal Reserve (Fed) and the European Central Bank (ECB) both increasing rates by 0.75%, along with a 0.50% raise by the Bank of England. Although these moves are more aggressive than the norm, this still only leaves rates at 3% in the US, 2.25% in the UK and 0.75% in the ECB, which has so far had little impact on inflation which is running at 8.3%, 9.9% and 10.1 % respectively. As a result, it is almost certain that further aggressive rate hikes will be announced in the coming months.
What is noticeable is that the investment backdrop is changing significantly. For over a decade, central banks were keeping interest rates at or just below zero and actively buying government and even corporate debt. These policies have now been eradicated. Not only are central banks raising rates they
are no longer buying bonds, and the Fed is effectively selling. Asset prices are having to adjust to this change. The adjustment is painful, volatile, and not yet complete.
UK based investors with global portfolios were somewhat resilient to the sell off as Sterling devalued against all major currencies. The devaluation was caused by the newly formed Conservative government under Prime Minister Liz Truss significantly easing fiscal policy to kick start the economy and improve its’ popularity with the UK electorate, with the next election only two years away.
The new fiscal package included a large spending plan to help households manage the sharp rise in energy prices as well as large tax cuts. In times of economic stability this would have been welcomed by the financial markets. Unfortunately, with inflation at nearly 10% and unemployment at near record
lows the markets questioned the wisdom of these additional stimulus measures. What made matters worse was that the Bank of England (BoE)appeared to be surprised with the policy change, which led to yields on gilts spiking as the markets became concerned with the sustainability of funding such a larger deficit while the BoE hiked rates to fight inflation. On the back of this the bond market became illiquid and the BoE had to step in and buy long dated bonds. This was ironic as the BOE had just a few days earlier confirmed their plan to begin selling gilts they owned to reduce their balance sheet. For almost a week the UK was referred to as behaving like an Emerging Market economy which was unfair in our view.
What we have learnt is that the fiscal deficits are beginning to matter again to markets, particularly when central banks are no longer able to help finance these deficits by quantitative easing. Rising interest rates will begin to bite as central governments look to manage their inflated fiscal deficits. The days of running large deficits enabled by low or zero interest rates has come to an end.
Rising interest rates, whether from fears of fiscal deficits or simply central banks tightening policy to fight inflation is not going to help equity markets. Yields on short term government securities are already reaching levels that will begin to pull money from stocks. As they go higher stock prices will
have to adjust. The markets keep hoping that the Fed is going to stop hiking rates soon and might even cut them next year (the so-called Fed pivot) and that inflation has peaked. The Fed at their latest press conference poured cold water on this view as it raised its forecasts to 4.4% and implied further hikes into 2023. This stance will continue to put upward pressure on the US dollar as other central banks are unable or unwilling to match the pace and scale of the Fed’s rate hikes.
The current economic backdrop does not look to be conducive for asset markets and it looks like these conditions will not abate in the short term and due to this we remain conservatively positioned and tactically invested in the energy and healthcare sectors.
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