Navigating complex markets

While the UK was quietly observing a period of mourning following the sad passing of Her Majesty Queen Elizabeth II, stock markets have been in back-to-school mode with transaction volumes picking up following the usual summer lull. The issues that concerned investors before the summer; high inflation, rising interest rates and slowing global growth, continue to weigh on investors' minds now.

The chart below shows performance of equities, government bonds and gold, in sterling terms and any income reinvested, so far this year.

As is often the case, equities have rebounded from the initial shock and subsequent lows of mid-June. This has left equities trading in a wide range as markets try to digest both positive and negative news. UK-based investors have benefited significantly from the relative strength of the US dollar against the pound. This is best illustrated by the performance of gold – in US dollar terms, gold is down 6.7% compared to a rise of 8.1% in sterling terms [1].

As central banks respond to inflation concerns with rapid rate hikes, government bonds continue to come under pressure and have generally underperformed equities so far this year. This highlights the importance of ensuring portfolios are well diversified not only in the equity portion, but also in non-equity components. Bond exposure encompasses a wide range of sub-asset classes and at Evelyn Partners we have generally avoided significant exposure to bonds that are sensitive to rising interest rates to mitigate the risks.

We also use alternative asset classes such as gold and infrastructure along with high-quality absolute return and hedge funds to provide alternative options to equities, to aid diversification where appropriate. This is, in our opinion, one example of how an investment professional can help investors to navigate this challenging investment environment.

Of course, looking to the past doesn’t tell us much about the future, which should be the focus for investors. There are a number of dynamics in play. Inflation continues to vex investors, with US Consumer Price Inflation (CPI) continuing to fall from its recent peak, but at a frustratingly slow rate compared to expectations. Here in the UK, inflation also dipped from 10.1% year on year in July to 9.9% in August [2].

We expect inflation to peak in the coming months as the rise in energy prices feeds into the figures. The announcement that the Government would cap energy prices may mean the peak will be sooner and lower than previously expected. The precise timing is difficult to predict and after the peak, the inflation rate probably won’t fall in a smooth line. With central banks keenly focused on taming inflation, talk of a ‘pivot’ towards a softer approach to interest rates looks premature.

The mini-budget on Friday 23 September introduced a raft of tax cuts and increased spending. This has raised concerns that the UK Government will have to borrow more and contributed to further declines in the stock market. The impact in financial markets was felt most in currency, and the pound (already weak against the US dollar) fell to lows not seen since 1985.

Our tax colleagues have sifted through the details of the mini-budget and have produced a series of articles looking at the announcements in detail:

The growth plan: what does Liz Truss’s announcements mean for you?

The growth plan: Stamp duty and land tax

The growth plan: income tax and national insurance rates

The growth plan: the repeal of off-payroll working (IR35) reforms

The growth plan: the impact on businesses

The growth plan: Venture Capital Scheme changes

Markets are currently being driven by the expectation of higher interest rates and higher inflation and the impact they have on disposable income and the cost of living. In addition, sentiment plays a large role and the escalation of the Russia-Ukraine war continues to weigh on investors’ minds. However, assuming inflation does come under control, it is important not to underestimate the stimulative effects that a reversal of current monetary policy (rising interest rates) can have ─ even if the economy continues to cool. Markets are forward looking, and a quick change in sentiment could help to drive a recovery in equities, while it is also worth remembering that company fundamentals also remain fairly robust.

Sources:

[1] Bloomberg. Global Equities is the MSCI All-Country World Index, UK Gilts is the iBoxx GBP Gilts 1-10 year index, Gold is the gold price in GBP terms. Data as at 21/9/22, in GBP terms and on a total return basis.

[2] Consumer price inflation, UK - Office for National Statistics