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Tatton Investment –Tuesday Digest

Please see below Tatton Investment’s Tuesday Digest (usually Monday) which looks at the current position in the US and how the upcoming midterms may impact on the markets. This digest was received this morning (20/09/2022):

Overview: The Fed prepares for more tightening 
As the period of mourning for Queen Elizabeth II ends, thoughts again turn to the war that continues to dominate our economy and markets, as it does throughout Western Europe and, to some degree Asia. Meanwhile, seemingly unaffected by the rest of the world, the US is blazing its own trail. This is predominantly because US energy security means it do not face the same input cost pressures. Nevertheless, inflation remains a problem for the US Federal Reserve (Fed) August consumer price data reflected a fall back in oil-related pressures, but tightness in the labour market continues to feed through. Therefore, the US is faced with a more structural inflation issue through looming wage-price-spiral dynamics than Europe. 

It does look like the Fed loosened its grip on the US economy during the summer and will now have to tighten harder, after the fallback in inflation expectations data resulted in a degree of complacency. This week’s meeting of the Federal Reserve Open Markets Committee is expected to result in an interest rate hike of at least 0.75%, bringing the Fed Funds rate up to 3.25%. More importantly, analysts suggest the peak for US interest rates is now around 4.5%.

While the US economy is stronger than expected, one should not overstate it. The summer bounce has been relatively muted and August retail sales disappointed. Seasonally, consumer spending picks up through the last quarter, so the Fed will be keen to see if consumers have just delayed their purchases. It showed determination in the first part of the year, and we expect it will reassert itself this week. We would not be surprised by a 1% rate rise (rather than 0.75%) and think the market is already prepared for the bigger move.

US corporate credit shows few recessionary signs
Declining business confidence and the aggressive Fed has led to fears that debt repayments will become too great, sending companies into bankruptcy. The US yield curve (measuring the difference in payment terms between short and long-term government bonds) is still inverted, often a reliable recession indicator, with investors getting paid less to lend over ten years than over two. Credit spreads – the difference between corporate and government bond yields – have swung up and down over the last few weeks on the back of new inflation data. They widened after last week’s release showed inflation still running hot, prompting expectations of more Fed tightening than previously anticipated. But the Fed is only tightening because the economy is strong, consumers are spending, and employment is holding up well. 

If a recession was looming, you would expect signs of stress in credit markets. While spreads have widened, acute stress has been contained so far. The fact that high yield credit in particular is doing so well speaks against imminent recession fears. Without a particularly sharp cost shock – like the one we are seeing now in Europe – economic strength should allow companies to deal with the rising cost of financing. As for recession indicators, we suspect they are down to global or technical factors, rather than a reflection of the US economy. The yield curve, for example, is skewed by the recent risk-off move from global investors – as many institutions are required to buy long-term US Treasury bonds. 

None of this is to say that things could not turn for the worse. Sharp rate rises take a toll on businesses, and sectors like commercial real estate are particularly sensitive to interest rate moves. But it would likely take a significant weakening to create widespread default pressures. By most measures, equities remain expensive relative to credit – despite the market falls this year. You could read that pessimistically as a sign stocks need to sink further, but it could also signal that corporate credit is undervalued, as backed up by balance sheet resilience. Ultimately, the difference between the two scenarios is market sentiment, rather than underlying conditions. For better or worse, that sentiment will be a deciding factor in how corporate credit fares from here.

US midterms hang in the balance
The US midterm elections are less than two months away, and when America votes, the world watches. Capital markets are focused on ‘money’ rather than political impacts, and some commentators are warning that the midterms could be a source of volatility in the coming weeks. As recently as July, polling showed the Republican Party on track to regain control of the Senate, but the Democrats are now in better cheer with their fortunes improving over the summer. We see the same trend in the House of Representatives, albeit to a much lesser extent. A Republican victory looked a sure thing a few months ago, but the current expectation is that President Biden’s Democratic party will retain or even strengthen control of the Senate, while the Republicans are expected to snatch the House of Representatives away. Ceding the lower chamber would still frustrate Biden’s agenda and compound gridlock in Washington. 

The state of the economy is generally a good guide to the ruling party’s fortunes. Consumer sentiment fell dramatically in the spring and summer, and the Democrats’ approval rating unsurprisingly declined with it. However, the swing may be partly due to the Supreme Court’s decision to overturn Roe v Wade, the landmark case which enabled nationwide access to abortion for the last 50 years. More worryingly for Republicans, it seems to have energised liberal voters. Unsurprisingly, Senate minority leader Mitch McConnell wants to steer the national conversation to inflation, the general economy and perceived “woke” liberal excesses. 

In reality, these mid-terms are unlikely to change fiscal policy dramatically, particularly given the likelihood of a split and gridlocked legislature. For markets, foreign relations could be the most important battleground, especially the relationship with China. Whether markets would prefer Democrats or Republicans in Congress is hard to say and the recent swings do not appear to have been a big factor in asset market moves. Rather than the fiscal deficit, the trajectory for the current account deficit and the US Dollar may occupy investors’ minds.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Cyran Dorman

Trainee Paraplanner

20/09/2022

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Church House Investment Management: UK Market Analysis – September 2022

Please see the below article from Church House Investments, providing analysis of the key factors currently impacting markets. Received yesterday – 14/09/2022

Have you ever slogged your way up a large hill and reached what you thought was the summit, only to discover that this was a false horizon and that you will have to push on higher? This is how markets felt in August.

After a rotten first six months of the year, there was a brief moment of respite when it looked as if the worst of the pain might have been felt with the panic sell-off in June and that things were at least not getting any worse than feared. This was swiftly extinguished by Putin turning off the gas taps to Europe, seemingly permanently this time, and Jay Powell (Chair of the Fed) flagging ongoing sharp interest rate increases at his Jackson Hole keynote address. Risk assets, from equities, to debt and most else in between, fell back again in late August and investors were again left licking their wounds.

Fundamental to weak equity markets in 2022 has been the weakness of sovereign and corporate debt markets. Gilt yields (that move inversely to their price) have tripled in 2022 and now stand at over 3%, levels not seen for any meaningful period since pre-2012 (remember that golden Olympics?). Falling prices of (theoretically) risk-free UK Government bonds (no comment on our new PM’s fiscal promises!) are always going to have a negative effect on assets higher up the risk spectrum, from corporate bonds, right the way up to small-cap equities (at the top of the risk scale). Sovereign bonds yields are unlikely to steady until the market feels that it has a handle on inflation and the path of interest rates. This is not to say that investors need (or could ever have) certainty on the path of inflation and rates, but the negative surprises need to stop coming.

In the midst of all this doom and gloom I am going to be controversial and give some points for optimism. Firstly, one has to suspect that with Nord Stream now fully shut down, Putin has played his ace card. Of course, he can continue to commit atrocities in Ukraine, but short of invading another European nation or threatening nuclear war, Putin’s power to hurt a Western world that has severed all possible ties with Russia has to be past its peak.

Secondly, the ex-Putin contributing factors to rising inflation are showing signs of calming. Anyone who has filled their car up recently will be relieved that the oil price has begun to retreat, while the price of industrial metals such as aluminium, iron ore and copper are sharply lower in the last six months. Shipping still takes longer than pre-pandemic, but the bottleneck is clearing – the time it takes to ship cargo across the arterial China-US route has fallen in 16 of the last 17 weeks. Cheaper commodities and quicker shipping should help to ease input cost inflation which, in turn, will reduce pressure to increase prices to the end consumer. All of this will take time to wash through and there is no hiding from the pain that high energy bills will cause to consumers this winter, but one look at the BBC News website will tell you that this is already widely known and priced into asset prices.

Market confidence is fragile and investors remain jittery. Despite significant declines in equity valuations across the board, few buyers have put their head above the parapet. However, it is interesting to see that some enterprising investors have stepped in recently, particularly in the UK technology sector, where valuations had reached notable lows. Over the last few weeks we have seen private equity bids for three UK-listed technology businesses: Aveva, Micro Focus and GB Group. While we were not shareholders in any of these businesses, we found these bids heartening vindication that all is not lost and that there are bargains to be had amidst the overwhelming negativity. At Church House we focus on the fundamentals of individual businesses, looking for unique companies that we believe can grow at steady rates over the long-term. From time-to-time fear will prevail in markets and we get opportunities to invest on behalf of our clients in such outstanding businesses at more than reasonable prices – now appears to be just such a time.

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Alex Kitteringham

15th September 2022

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Weekly Market Commentary – Nord Stream 1’s closure has led to volatility in the European energy market

Please find below, a weekly market commentary received from Brooks Macdonald yesterday afternoon – 12/09/2022

  • Central banks continue to dominate sentiment with the ECB raising rates by 75bps and bond markets expecting a similar move from the Fed
  • Nord Stream 1’s closure has led to volatility in the European energy market however prices fell last week as investors positioned for government intervention
  • The US CPI release on Tuesday will be a key input into the Fed’s interest rate policy decision next week

Central banks continue to dominate sentiment with the ECB raising rates by 75bps and bond markets expecting a similar move from the Fed

Central banks remained in focus last week as Federal Reserve (Fed) Chair Powell reinforced his hawkish message, saying that he was entirely focused on fighting inflation. These words impacted bond markets with a 75bp rate hike almost entirely priced in for the Fed’s September meeting. The European Central Bank (ECB) meanwhile raised interest rates by 75bps with President Lagarde noting that inflation was ‘far too high’ and that policy needed to tighten substantially. Despite this, equities performed well, mostly as prior trading weeks had come to terms with the reality that hawkish central bank rhetoric appears to be here to stay for the short term.

Nord Stream 1’s closure has led to volatility in the European energy market however prices fell last week as investors positioned for government intervention

With European energy markets still reacting to the closure of the Nord Stream 1 pipeline, EU energy ministers met on Friday to start forming a plan to help mitigate the energy price surge. Ministers pointed to a large range of tools that they could use to bring price levels under control. Markets were impressed by their fervour, driving European natural gas futures down over 6% on Friday. Over the weekend, the news that Ukrainian forces had successfully executed a counter offensive in the Northeast of Ukraine was welcomed by market participants. With Nord Steam 1 closed, the relative balance of power in the Ukraine War is arguably even more important for investors. Of course, progress by Ukrainian forces does risk a more aggressive escalation by Russia however equities have initially taken this positively.

The US CPI release on Tuesday will be a key input into the Fed’s interest rate policy decision next week

This week’s highlight is likely to be the US Consumer Price Index (CPI) report on Tuesday which will be front and centre of the Fed’s mind when they meet on 21st September. The market is expecting US Core CPI to actually increase year-on-year from 5.9% to 6.1% as housing costs continue to push up the core figures. By contrast, the fall in energy costs in recent months is expected to lead to a substantial fall in headline CPI with the annual rate moving from 8.5% to 8.1%. The month-on-month figure is expected to show a -0.1% decline, reflecting the sharp fall in US gas prices as well as global oil benchmarks.

Given the proximity of the Fed meeting, US central bank speakers are in the communication blackout window meaning that we will have little live reaction to the CPI print. That said, with investors very conscious of the sustained hawkish drumbeat of recent weeks, market pricing will quickly swing based on the CPI report.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

David Purcell

13th September 2022

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Tatton Investment – Monday Digest

Please see below Tatton Investment’s Monday Digest which looks at last week’s events in the UK and globally. This article was received this morning (12/09/2022):

Overview: The end of eras 

With great sadness, we pass from the second Elizabethan age. Our Queen was a constant during this period of intensely rapid change. Across the political spectrum, we can acknowledge her ceaseless responsibility to her people. She retained her dignity as monarch throughout her reign supported by her faith and her humanity that was obvious to all.

Despite her failing health, her last official act on Tuesday was to invite Liz Truss to form a government, the 15th Prime Minister during her reign. The official pictures show the Queen undertaking the task with a warm smile and a welcoming handshake.

New Prime Ministers can be signals of change and Truss, showing initiative, has moved quickly to propose action on the energy crisis. Within the energy policy proposals, a six-month energy price cap for businesses will be welcomed by many. 

Her finance-related cabinet team is also imbued with a radical pro-business deregulatory agenda. Kwasi Kwarteng is said to focus on policies that create an attractive UK environment for global firms. The current refusal to countenance windfall taxes is such a signal, as is the proposal made (in the Conservative leadership campaign) to cut corporate taxes. The appointment of John Redwood also signals a wish to get back the reforming years of Margaret Thatcher’s premiership. 

The speed of Truss’s proposals is commendable, but it is also clear that she has announced only partially-formed policies. The Institute for Fiscal Studies and the Resolution Foundation both point out that is remarkable for such huge proposals to be costed only in the most sketchy way. There is no real clarity on how they will be achieved. 

This is not to say that the policies will be ill-formed. The aims are laudable but we just don’t know yet whether they will be achieved in a way which solves problems or adds to them. 

A further aspect is a growing dissonance between fiscal and monetary policy. Both Bloomberg and JP Morgan Research expect that the Bank of England will still raise rates, although the energy price caps have lowered UK inflation forecasts over the next year, and hopefully go some way to lowering future inflation expectations. Both expect that the fiscal boost will support the economy enough to avoid more than one-quarter of negative growth next year.

This means that both expect rates to peak at a higher level than before. Neither the markets nor the analysts above expect rates to go higher than 4%. 

The biggest conundrum will be around the new debt that will have to be issued by the Government. During the pandemic, the Bank of England bought much of the debt issued, difficult to stomach currently while inflation and a weak sterling are its monetary problems. Over the past two weeks, gilt yields have risen and the Sterling has fallen. Potentially, they could go further if the details of the policies show open-ended costs.

During her campaign, Truss talked of re-establishing a money supply-led monetary policy, in the manner of the early Thatcher years. However, her fiscal largesse is in some way from the economic policies that Thatcher favoured. The era of neo-classical economics may be also passing.

Coping with the energy crisis

The post-pandemic inflation boom has taken many turns over the past couple of years and pushed central banks into current aggressive policies. Fading growth and business confidence (outside of the US, at least) have lessened concerns of a wage-price spiral, but the war in Ukraine has kept inflation pressures excruciatingly high. Now, inflation pressure comes mostly from the cost of energy, caused by a severe cost-push around natural gas and electricity – and it is overwhelmingly focused on Europe.

All European economies face serious problems around energy supplies. With a harsh winter looming and no sign of loosening supply, blackouts and gas rationing are expected in Germany and some of its neighbours. Costs are skyrocketing for consumers and especially businesses. 

The policy response to this crisis is crucial. Inaction is not an option, but the ‘how’ is difficult. If government aid creates an increase in the aggregate energy demand, the world’s undersupply will grow, and inflation will only get worse.
 
Finding that balance has led to various plans from politicians. Germany has set out various support schemes for households, with utility companies able to for state support, while new Prime Minister Liz Truss announced a general price cap on typical household energy bills at £2500 and it appears UK companies will benefit from a price cap lasting six months. 

This will certainly lower consumer energy prices in the short term and reduce CPI inflation readings that Central banks usually target. The problem is that these do not address the supply-demand imbalance. Without higher energy prices, there is no incentive to reduce consumption meaning price pressures remain. 

In mainland Europe, the EU is reportedly planning to change the way the electricity market functions to avoid sudden price rises, aiming to decouple end energy prices from wholesale gas prices – to soften any sudden supply-side shifts – and proposes to redistribute energy companies’ excess profits. 

The G7 nations announced that they will seek to impose a price cap on Russian oil, starting in December for crude and then in February 2023 for refined products. While this has primarily been presented as a geopolitical play to hurt Moscow’s finances, it could also have a critical impact on prices down the line. Unfortunately, the cap applies only to oil which is not the key driver of Europe’s price pressures. 

In many countries, spending plans or price caps are being financed by (or coming at the expense of) energy company profits. While there is renewed political pressure on Truss to apply a ‘windfall’ tax on energy companies, it appears the current support package will be fully debt financed and debt-financing is a risky move in the current economic environment keeping real prices high and creating inflationary pressures further down the line.

This is likely to put pressure on the Bank of England (BoE) to tighten monetary policy further meaning that we are in a rather “classical” situation where a higher fiscal deficit puts upward pressure on yields. After years of fiscal austerity, coupled with low inflation readings and therefore supportive monetary policy, this is a different framework to operate in. 

A tighter monetary policy will push borrowing rates up and weigh on businesses and households alike, but a benefit of the Government’s plan is that borrowing can be more targeted than interest rates. In the best-case scenario, this creates actual wealth redistribution and in the very worst case, it damages the whole economy and creates unemployment. 

The Pound has already fallen to its lowest dollar value in decades, and further debt or inflation pressures could weigh on it further. It is therefore vital for the BoE to keep its independence from Government. From a more general political point of view, the UK and the EU are at the cusp of defining Europe’s (energy) future but without investment to sufficiently shift its energy infrastructure disruptions are more, not less, likely.

Global property prices fade

The current inflation spike has hit virtually all parts of the world economy, and property is no exception – according to reports global house prices jumped 11.2% from April 2021 to March 2022 – the first double-digit jump in property prices since the global financial crisis of 2008, The rise was broad-based, affecting both emerging and developed economies. 

If this was good news for homeowners, it points to a real stretch of affordability across multiple markets. House price gains have been a big contributor to the cost-of-living crisis facing the developed world. Even adjusting for inflation, global residential property prices grew 4.6% over the twelve months to the end of March 2022 and most likely hits buyers and renters hardest. Adjusting for real wage loss due to inflation we estimate that the surge is around 7%.

Affordability is the key thing to watch and, on that basis, the inflation wage-adjusted figure is revealing. House price rises are paper gains until you move and without a supply of sellers consumers end up being squeezed for housing. For property prices to comfortably rise above inflation indicates how strong the market was – and suggests that house prices themselves are a big contributor to global inflation.

While property prices are certainly a big part of this year’s inflation story, they were on an uptrend long before the current supply-side shocks. Looking back at the twelve years since 2010 analysts at the Bank for International Settlements calculate that real house prices are 29% above where they were after the global financial crisis, and the gains are again unevenly shared: EM residential property has gained 19% while developed markets have jumped 41% over the same period. From a longer-term perspective, this is quite astonishing.

What does this mean currently, and for the future of the housing market? Developed economies have pushed this limit over the last decade, by keeping interest rates at historic lows and pumping markets full of liquidity meaning house buyers could borrow to keep with prices, even if their wages fell behind.

Now, the borrowing environment is entirely different. Central banks have tightened policy to combat inflation, and are signalling higher rates ahead but we are in a severe cost-of-living squeeze and falling real disposable incomes. It is hard to see how demand could keep up with soaring prices. This is not to say a crash is coming – but a slowdown or slight reversal seems inevitable.

More recent signs back this up. After climbing high into the first three months of the year, Australian and German house prices seem to be falling. In the UK, prices are still increasing, but the gains are small and below consumer price inflation, though importantly our housing market no longer likes a source of inflationary pressure.

China – is now a key region in the global property market with the collapse of property developer Evergrande creating severe knock-on effects on the country’s house prices. China has also impacted other nations’ property markets, especially in the cities among new-build apartments. 

The main exception to the recent global price stagnation is in North America, where house prices are still rising at or above inflation. During the pandemic and up to this April, US and Canada saw new-build costs rise sharply and now mortgage costs have hit 10-year highs. This removes much of the surge in demand and new build costs are back at pre-pandemic levels. If that helps to reduce some price pressure, the strong labour market continues to give housing prices strong support.

The timing of this price reversal and the difference in the fortunes of the US should be expected. The war in Ukraine has hit Europe economically the hardest making cost pressures more pronounced than in North America, squeezing its consumers more. US energy costs have been much milder, and its consumers have fared better. How much longer that can continue remains to be seen – particularly with the Fed tightening policy. But with winter approaching, we should not expect the outperformance to end in the short term.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Carl Mitchell – Dip PFS

Independent Financial Adviser

12/09/2022

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Daily Investment Bulletin

Please see below article received from Brooks Macdonald this morning, which provides an update on markets following the sad news of Her Majesty Queen Elizabeth II passing yesterday.

What has happened

The very sad news was announced on Thursday that Her Majesty Queen Elizabeth II had died, ending her reign as the longest-serving British monarch in history, and leaving the nation and many around the world in mourning. UK Prime Minister Liz Truss said of the Queen, “She was the very spirit of Great Britain – and that spirit will endure.”

In financial market news

On Thursday, US Treasury bond yields moved higher as Fed Chair Powell took another opportunity to talk tough on inflation. Speaking at a conference on Thursday, Powell said the Fed would not flinch in its efforts to curb inflation “until the job is done”. Despite the hawkish message, equity markets managed to end up on the day – arguably feeding a sense that maybe equity markets have already baked in quite a lot of negative sentiment as regards the interplay between economic growth worries and inflation pressures. Later today, EU energy ministers are due to meet in Brussels to discuss emergency measures to help with high energy prices.

European Central Bank hikes 75bps

The ECB raised interest rates by 75bps on Thursday, representing the biggest single hike since the formation of the single currency. Despite the unprecedented hike, ECB President Lagarde pledged “several” future rate moves to come in order to get inflation heading back towards the bank’s 2% target, and that “we think it will take several meetings”. While acknowledging 75bp hikes was not the norm, Lagarde declined to rule out a similarly large move in the future. In response to the comments, Eurozone bond yields rose following the meeting, with Italian 10 year yields remaining close to 4%.

UK government announces an household energy price cap freeze for 2 years

On Thursday, UK PM Truss announced an unprecedented intervention in the energy market. Under the new policy, ‘a typical UK household will pay no more than £2,500 a year on their energy bill for the next two years from 1st October, through a new Energy Price Guarantee which limits the price suppliers can charge customers for units of gas.’ For businesses there will be ‘equivalent support’ for 6 months, and afterward ongoing support for ‘vulnerable industries’, such as hospitality. Adding to the previously announced £400 energy bill discount for this year, the government said this ‘will bring costs close to where the energy price cap stands today’. Estimated by some to be in the region of £150bn, the costing of the government’s energy policy is due to be set out by the Chancellor Kwasi Kwarteng in a fiscal statement in the coming weeks. For perspective, a £150bn cost, if that is the right estimate, would be more than double the £70bn cost of the UK’s COVID furlough scheme during the pandemic.

What does Brooks Macdonald think

The UK government’s intervention in the energy market creates a difficult balancing act for the Bank of England, which is due to meet next week (15 September). The debate hinges on whether the fiscal support announced is net inflationary over time, requiring a relatively tighter monetary policy response. The UK government expects the policy to dampen inflation by between 4 and 5 percentage points. For context, the Bank said last month that inflation would be around 13% over Q4 2022. Against this, considering the wider implications of the new energy policy, by alleviating pressure on household budgets, it might end up supporting consumer demand and hence price pressures elsewhere in the economy over the longer term.

Index 1 Day1 Week1 MonthYTD
 TRTRTRTR
MSCI AC World GBP 0.9%1.1%0.7%-3.1%
MSCI UK GBP 0.4%1.6%-2.3%3.6%
MSCI USA GBP 0.8%1.6%1.8%-1.3%
MSCI EMU GBP 0.4%2.5%-3.4%-14.4%
MSCI AC Asia ex Japan GBP 0.2%-1.8%0.5%-6.5%
MSCI Japan GBP 2.7%-1.1%-1.4%-7.0%
MSCI Emerging Markets GBP 0.2%-1.5%0.9%-6.3%
Bloomberg Sterling Gilts GBP -1.4%-2.4%-11.6%-22.5%
Bloomberg Sterling Corps GBP -0.7%-1.4%-8.9%-19.1%
WTI Oil GBP 2.1%-3.1%-3.2%30.9%
Dollar per Sterling -0.3%-0.4%-4.8%-15.0%
Euro per Sterling -0.2%-0.9%-2.9%-3.3%
MSCI PIMFA Income 0.1%0.3%-2.7%-7.0%
MSCI PIMFA Balanced 0.1%0.5%-2.2%-6.1%
MSCI PIMFA Growth 0.3%0.9%-0.9%-3.8%
Index 1 Day1 Week1 MonthYTD
 TRTRTRTR
MSCI AC World USD 0.8%0.7%-4.2%-17.8%
MSCI UK USD 0.3%1.1%-7.1%-12.2%
MSCI USA USD 0.7%1.1%-3.2%-16.3%
MSCI EMU USD 0.3%2.0%-8.1%-27.4%
MSCI AC Asia ex Japan USD 0.1%-2.3%-4.5%-20.7%
MSCI Japan USD 2.6%-1.5%-6.2%-21.1%
MSCI Emerging Markets USD 0.1%-1.9%-4.1%-20.5%
Bloomberg Sterling Gilts USD -1.2%-2.7%-16.2%-34.2%
Bloomberg Sterling Corps USD -0.5%-1.7%-13.6%-31.4%
WTI Oil USD 2.0%-3.5%-8.0%11.1%
Dollar per Sterling -0.3%-0.4%-4.8%-15.0%
Euro per Sterling -0.2%-0.9%-2.9%-3.3%
MSCI PIMFA Income USD 0.0%-0.1%-7.5%-21.1%
MSCI PIMFA Balanced USD 0.0%0.0%-7.0%-20.4%
MSCI PIMFA Growth USD 0.2%0.4%-5.8%-18.4%

Bloomberg as at 09/09/2022. TR denotes Net Total Return.

Please check in again with us soon for further relevant content and market news.

Chloe

09/09/2022

Team No Comments

Global Markets: Seven issues to watch in September

Please see the below article from Invesco highlighting the key factors currently influencing global markets. Received yesterday afternoon – 07/09/2022

So much has happened in recent days that it’s hard to know what’s most important to follow this week. Following are a few thoughts on what I’ll be looking at most closely:

1. Europe’s response to a natural gas cutoff

European Union (EU) member states have been frantically building energy reserves in advance of winter, working toward EU targets of at least 80% storage capacity by Nov. 1. However, last week Russia announced it would not be reopening the Nord Stream I pipeline (which had been temporarily shut down for repairs), throwing a wrench into those plans. Russia has clarified that gas supplies will not resume until anti-war sanctions are lifted, so Europe will have to get through the winter without Russian gas (unless plans to continue supporting Ukraine change considerably). While reserves have been built up in some large EU member states well ahead of schedule — with storage capacity at the EU level at 80% as of the end of August — that only covers approximately 20% of average annual usage, which is concentrated in winter. If this winter is relatively cold, this latest action by Russia takes Europe to the verge of a supply shock possibly of a similar magnitude to the Arab and Iranian oil embargoes of 1973 and 1979, respectively.

Despite Brexit, the UK is in no better position than the rest of Europe. The UK has virtually no storage and is integrated into the EU pipeline network as a transit hub for Norway’s gas and US/MENA (Middle East and North Africa) liquefied natural gas (LNG).

This shifts the focus to substitutes for Russia’s natural gas. The good news is that Germany’s construction of two LNG terminals is expected to be completed this winter. It is estimated that these two facilities could provide about 60% of what had been the recent flow coming from the Nord Stream I pipeline, which was only about 20% of capacity. There is also the potential to increase natural gas imports from Norway. In addition, Germany just announced it will be keeping its nuclear plants open in the coming year in order to help provide energy during this crisis.

However, finding substitutes for Russian natural gas will only alleviate some of the pressure created by the natural gas cutoff. This crisis also has the potential to create more political division, calling into question ongoing European support for Ukraine. Over the weekend, approximately 70,000 protesters gathered in Prague to protest high energy bills and demand an end to sanctions against Russia over the war in Ukraine.

2. European Central Bank meeting

Since mid-August, the overnight index swaps (OIS) market has been pricing in a more hawkish monetary policy stance by the European Central Bank (ECB). The OIS market now expects cumulative ECB policy rate hikes for 2022 and the first half of 2023 to be 125 basis points higher than anticipated at just the beginning of August. Although the OIS market tends to overestimate rate hikes, this large movement reflects a sizable change in market expectations. It appears that various hawkish comments made by a number of ECB officials moved market expectations, including those by Isabel Schnabel, a member of the ECB Executive Board, at Jackson Hole in late August.     

This hawkish stance by the ECB has had a considerable impact on global markets. It has resulted in higher bond yields across the Euro Area but also has arguably contributed to a rise in the US 10-year bond yield — along with Federal Reserve Chair Jay Powell’s own hawkish comments. The entrenchment of hawkishness across major central banks has in turn exerted downward pressure on global technology stock prices.

The stakes are high. The last two times the ECB hiked into rising headline inflation led by energy, in 2008 and again in 2011, were arguably among the most detrimental policy errors by a major central bank ever. The first precipitated the eurozone financial crisis; the second exacerbated it, almost blowing up the financial system and the euro, in my view. The inflation measure that the ECB targets is headline Harmonised Index of Consumer Prices (HICP) inflation, but it has paid closer attention to core HICP since Mario Draghi’s presidency, at least in part because core HICP argued against raising rates in 2008 and more so in 2011.

Today, core HICP is rising sharply, which does not help ECB doves. Not surprisingly, ECB hawks are advocating for a 75 basis point hike due to high, rising inflation and tight labor markets. However, the eurozone economy is very vulnerable. S&P Global recently sounded an alarm on the eurozone economy, especially the buildup in inventory: “The euro area’s beleaguered manufacturers reported a further steep drop in production in August, meaning output has now fallen for three successive months to add to the likelihood of GDP (gross domestic product) falling in the third quarter. Forward-looking indicators suggest that the downturn is likely to intensify — potentially markedly — in coming months, meaning recession risks have risen. Falling sales have not only led increasing numbers of factories to cut production but have also meant warehouses are filling with unsold stock to a degree unprecedented in the survey’s 25-year history. Similarly, raw material inventories are accumulating due to the sudden and unexpected drop in production volumes. Weak demand and efforts to reduce high inventory levels are therefore combining to drive production lower in the months ahead ….”

Needless to say, we will be waiting with bated breath for the ECB’s decision this week.

3. The new UK prime minister and sterling

There has been a relatively high level of uncertainty around newly minted UK Prime Minister Liz Truss, given her change in political ideologies over time as well as her changing position on several issues since becoming a leading contender for prime minister. There is particular uncertainty around the Bank of England in a Truss government, given her comments about revisiting and potentially altering the central bank’s mandate. There’s also concern that she might confront the EU by suspending the Northern Ireland protocol in the Brexit trade agreement.

However, what we have heard most recently is somewhat more encouraging for markets: that Truss believes in the independence of the Bank of England, and that her government is preparing to provide $170 billion in fiscal stimulus to help alleviate the pain being caused by rising energy prices to consumers and small businesses. This stands in contrast to previous statements articulating a preference for tax cuts over aid— although tax cuts may also remain in the mix. Sterling has weakened significantly this year, although against the backdrop of US strength against most major developed and emerging market currencies. Sharpening clarity on Truss’ policies could see sterling reverse some of its losses.

That said, such a strong effort at fiscal support — which may be necessary given the cost-of-living crisis — would take place amid super-tight labor markets (UK unemployment is in low single digits; supply challenges due to the energy crisis, Brexit, labor shortages; and inflation already in the double-digits; and enlarged budget and external current account deficits). This substantial fiscal stimulus could mean the Bank of England may have to tighten more than otherwise and may have difficulty bringing inflation back down towards target. Sterling and UK domestic-facing assets could continue to underperform other major markets as a result.

4. China stimulus

China’s latest COVID wave has led to greater stringency, including some forms of lockdown, in cities such as Chengdu and Shenzhen. So far, the impact to economic activity seems much smaller than what we saw in the first half of the year as policymakers try to balance economic considerations along with virus control.

While the risk of another economic downturn has risen, so have stimulus measures. We anticipate more pro-growth policies could be announced as we get closer to the Party Congress, and we expect that could lead to a Chinese stock market rally.

5. The yen

The Japanese yen has fallen below 140 per US dollar for the first time in nearly 25 years. This is mainly a result of the strong US dollar. However, the Bank of Japan (BoJ) has been steadfast in not raising rates, as central banks around the world have been tightening monetary policy (the Reserve Bank of Australia just raised rates by 50 basis points). Financial firms’ forecasts for the yen are being revised down, as more erosion is anticipated. This seems likely to be reversed only if BoJ officials were to signal a change to policy, and that seems unlikely at this juncture given what Governor Haruhiko Kuroda has communicated thus far. In addition, there are certainly some benefits to Japan’s economy from a weaker currency.

6. Bank of Canada decision

The Bank of Canada (BoC) meets this week for the first time since its somewhat shocking decision in July to raise rates by 100 basis points. Despite high inflation, Canada’s economy is quite strong — far less vulnerable than the eurozone or UK economies — and so a substantial rate hike is likely to be well tolerated, in my view. Consensus expectations are for a 75 basis point rate hike, and that seems appropriate given conditions in Canada, as well as BoC governor Tiff Macklem’s desire to “front load” rate hikes.Hiking 175 basis points in two months is a lot, however, and given that the goal is “front loading,” I can’t help but wonder if the Bank of Canada will make a “subtle pivot” to a less aggressive path in subsequent meetings. We can look for clues coming out of this meeting, especially a focus on being more data dependent.

7. Copper prices

Finally, I think “Dr. Copper” has historically been a relatively reliable leading indicator of slowdowns, recessions, and expansions. Copper prices have been falling since their recent peak last March, under pressure because of reduced demand from China and a general tightening of financial conditions globally. If copper prices continue to decline, it could signal a major global slowdown is in the offing (although it is worth noting that any drop in commodity prices can also be a positive in this environment given that it can alleviate inflationary pressures.) We will want to follow prices closely for clues on the magnitude of the economic slowdown.

Please continue to check our blog content for advice and planning issues from us and leading investment houses.

Alex Kitteringham

8th September 2022

Team No Comments

Truss confirmed as new PM

Please find below, an insight into Liz Truss becoming PM received from Brewin Dolphin yesterday evening – 05/09/2022

Following the news that Liz Truss will become the next prime minister of the United Kingdom, Guy Foster, our Chief Strategist, looks at what this means for investors.

Despite not being the favoured candidate among Conservative MPs, Liz Truss has been the frontrunner since the contest was put to the party membership as a straight choice between the foreign secretary and the former chancellor, Rishi Sunak.

The two candidates have been campaigning at hustings events for the last five weeks, with the debate frequently becoming fractious between the two.

Both had talked of their ambitions for growth based on lower taxes.

However, there were some clear dividing lines, particularly with their proposed approaches for managing the cost[1]of-living crisis. Truss has argued for tax cuts immediately while Sunak prioritised curbing inflation first. Both would have needed to adjust their plans in light of the latest increases in gas prices and the prospect of real social unrest this winter.

All incoming prime ministers presumably have a pretty full inbox when they arrive, but this seems particularly the case this time around. As a result, much attention has been focused on the candidates’ statements around the financial support they would offer if they became prime minister.

Truss had said she would hold an emergency budget in September, but that has subsequently been relabelled as a fiscal event where she is nonetheless expected to deliver some of her core tax commitments.

Tax cuts?

There have been a number of tax cut proposals floated over the course of the campaign. Two of the most notable include reversing her rival’s increases to national insurance (the health and social care levy) that was introduced in April, and cancelling the planned increase in corporation tax to 25% that had been due to come in from April 2023.

Alongside those, there have also been pledges to cut fuel duty and suspend the green energy levy, as well as less specific plans to support people with energy costs through the winter. These suggestions are all designed to put more money back in people’s pockets.

None of these pledges will come cheap; the first two alone are forecast to cost almost £28bn by 2023-241.

Truss also considers that the tax system would be fairer if households were treated as a single tax entity; this would reduce the tax burden on those providing unpaid care, but might incentivise people to leave low paying jobs.

Of course, we will have to wait and see what changes the new prime minister chooses to make once she has her feet under the desk – the economic choices that need to be made may seem less palatable than when discussed on the hustings.

The impact on investors

It’s important to remember that the performance of the UK economy is usually relatively muted in its impact on investment portfolios. Most large UK companies are not particularly exposed to the UK economy, being more multinational in nature. For the largest companies, their country of listing is almost a historical accident.

However, some companies do have a specific UK focus, particularly supermarkets and some other retailers as well as some financial companies.

As you move further down the size spectrum, many mid and smaller sized companies will be progressively more exposed to their local market. If investors believe UK consumers will find life hard (as they do) then they will value companies selling to those consumers a little less generously.

 And there are additional effects too, as most UK investments will be affected to some extent by the outlook for the pound and interest rates.

In the run up to the result, the pound has been very weak.

That reflects the particular challenge the UK is facing in terms of soaring inflation, most notably from rising energy prices. The most dramatic weakness has been relative to the dollar, but that is a reflection of dollar strength as much as sterling weakness. Recently though, the pound has been underperforming the euro as well and that should be concerning for Truss, because the pound weakened as her likelihood of winning increased.

Similarly, government borrowing costs, which were rising as a result of the steeper trajectory of UK interest rates, seemed to rise faster as a Truss victory became more likely.

The new prime minister has successfully convinced the Conservative membership she is the right person for the job, but delivering on her promises will be difficult.

She has already been accused of designating the presentation of her economic plans as a fiscal event, rather than a budget, because that will avoid the need for the Office for Budget Responsibility (OBR) to scrutinise them. The markets, however, are passing judgement on them already.

The good news is that the pound’s weakness has been a benefit for the majority of UK companies who earn their revenue in foreign currencies. It has been a bigger benefit for overseas equities within client portfolios.

It does make holding longer-dated UK government bonds risky if, as Sunak has suggested, the UK were to lose the confidence of the markets. However, the chances of a default on a UK government bond are virtually nil because the central bank can print its own currency.

While shorter-dated government bonds anticipate future increases in interest rates and so are already providing a more attractive yield than is available in bank accounts, a quirk of the pandemic-era issuance means that, for many UK taxpayers, holding short-dated government bonds as a savings instrument is often hugely preferable to keeping cash in deposits.

The importance of the markets

The UK has a history of being unable to follow through on some policies because of the market’s reaction. One of the most notable examples was its withdrawal from the exchange rate mechanism, which ended up being economically advantageous for the economy.

Famously James Carville, economic advisor to Bill Clinton, once said: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

The new prime minister will need to have a policy agenda which appeals to her MPs, their voters, and eventually the OBR, and is at least tolerable for the markets.

The implications for portfolios are that we could see further weakness in bonds and the pound until the market builds confidence in the new prime minister. We protect against the weak pound by holding overseas securities. Weaker bonds are a more immediate threat and so we are cautious on this part of the market. However, the weaker they become, the higher the yields they will offer for the future.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

David Purcell

6th September 2022

Team No Comments

Tatton Investment – Monday Digest

Please see below Tatton Investment’s Monday Digest which looks at the current position in UK and Europe and what September may bring. This digest was received this morning (05/09/2022):

Overview: Europe still waiting for policy action

Last week investor attention turned towards what looks like an increasingly bleak winter ahead. The delicate equilibrium we wrote about last week has clearly once again been disturbed. It hasn’t helped that while unacceptable cost shock pressures have hit households and businesses across Europe, very little concerted action has been announced in response. In the UK, all eyes are on the new incoming Prime Minister, while the European Union (EU) is held up by the complexity of the problem paired with the terrible structural slowness of policy makers making decisions. This leaves businesses and households feeling more vulnerable. The energy supply shortfall that needs to be overcome by lower demand is estimated to be around 10-15%, which at current price levels will be massively overshot and lead to an unnecessarily excessive economic and mental health burden to everyone across Europe. Governments will need to devise a policy framework that combines the incentivisation that the price mechanism provides with means of soft (incentivised) energy rationing that achieves the same supply-demand equilibrium, but without the hardship that excessive price signals would cause for households and businesses.

Turning to recent market action in more detail, the past few days have seen markets fall and daily volatility has picked up, but to a much lesser extent than during the falls of earlier in the year. The falls in equity markets have been accompanied by falls in government and corporate bonds, much as when happened at the beginning of 2022 and again in June. However, because of the reduced intraday volatility levels there is much less of a sense as back then that monetary liquidity is draining. Indeed, US retail investors that were heavy sellers of assets during that period appear to be either less important or less scared now.

Looking ahead, September can be the most difficult month of the year. Investors will therefore not be holding their breath for a reversal of August’s falls – even though past seasonality trends have not provided particularly helpful guidance during 2022. However, either way, we are not pessimistic, as one of the main sources of equity market weakness this year has been the rise in US bond yields. Last week, those yields bounced back up after the US Federal Reserve (Fed) said it remained more concerned about labour market tightness above anything else. August data published last Friday showed a rise of 315,000 non-farm payroll jobs, still well ahead of the average 185,000 jobs per month of the 2010-2019 decade. This is an ‘improvement’ over July’s 528,000 new jobs number, but indicates that the Fed is unlikely to pivot on near-term policy anytime soon. Despite the Fed’s inflation concerns, the apparent stability of the US in the face of trouble elsewhere led to a sharp rise in the value of the dollar, backed up by a general risk-off move by global investors, in turn lessening the price-push impact of import prices.

For Europe, energy prices remain the focal point. Russia (officially Gazprom) shut down the flow through the Nord Stream pipeline and blamed sanctions and Siemens for “maintenance” issues. The shutdown was extended to “indefinite” late on Friday, and it appears Russia is determined to increase the pressure on European nations with continued supply disruption holding prices high, while not shutting of the gas supply completely to retain the leverage over European politics.

Emerging markets enjoying their time in the sun

Emerging Markets (EMs) have fared quite well recently, relatively speaking at least. Traditionally, EMs are very cyclical – expanding in times of global growth and falling back during the global economy’s low points. But while the world is undeniably in a slowdown (which became only more apparent over the month) EMs have not suffered as one would usually expect. At first glance, high energy prices would be a likely explanation. EMs are often reliant on commodity exports, meaning that high prices for raw materials can deliver a big boost. But the flaw in this argument is that the energy crunch is primarily in the natural gas market, specifically around Europe. EMs as a whole do not have a great exposure to European gas prices, and are unlikely to benefit from the supply-side tightness there. Energy issues have lately not been reflected in oil and metals prices, for example, which both had a lacklustre August. By comparison, food exporters such as Brazil have done well, despite the apparent fallback in developed world consumer demand.

Granted, from a longer-term perspective, commodities are in a good position. Price pressures are significantly higher than before the pandemic, and those forces are unlikely to dissipate any time soon. Pessimists point to a looming global recession and structural shake-ups from Russia’s war on Ukraine, which could undermine demand for commodities and thereby damage EMs. But the structural backdrop is still supportive of commodity prices – particularly for metals. A prolonged period of commodity strength and a favourable outlook have allowed many EMs to improve their trade balances. Potentially weak commodity demand could undermine some of that improvement, but many EMs have the additional benefit of proactive monetary policy last year. Latin American countries in particular began aggressively tightening interest rates in late 2021, and now have a fair chance of avoiding recessions as it gives them room for easing much earlier than developed countries.

Despite the positives noted above, anxiety lingers for EM investors. EMs have certainly held up better than expected, but what this means for the future outlook is deeply uncertain. Ultimately, the key factor is how bad the global economy gets. For all of the doom and gloom lately, nominal growth has held up well across the world. And while we are certainly in a slowdown, there is no global recession yet, and hence no significant pullback in commodity demand. In fact, fiscal stimulus is forthcoming in the US, Europe, China and Brazil, which will bolster growth in the months ahead. This is likely to lead to further monetary tightening from major central banks in developed markets, as has already been signalled. That scenario will be the real test for EMs. We will see whether EM success is structural and genuine, or just a fluke. The worst could be yet to come for developing economies, but things are at least looking positively different for some EMs for now.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Cyran Dorman
Trainee Paraplanner

05/09/2022