Given events of the last few days we have decided to bring forward our monthly market commentary to hopefully provide a degree of comfort to clients. Whilst clearly unsettling, we believe it’s important to understand the most recent headlines and market reactions, in context…
In an effort to tame inflation, central banks around the world have embarked on tighter monetary policy throughout 2022, primarily through raising interest rates. As is often the case, the Federal Reserve in America have been leading the way with United States base rates increasing sharply from a range of 0 – 0.25% to 3 – 3.25% over a six-month period. Base rates have implications for yields on government debt and in the low yield world that we’ve been in, can make one country’s debt relatively more attractive. This is particularly so when it’s a perceived “safe-haven” like the US, leaving the rest of the world had to play catch-up. Higher rates also make a currency more desirable, and this has helped fuel the strengthening dollar.
And so, a backdrop of rising rates and a strong Dollar have caused problems to fixed income investors for quite a few months now which to be clear, until last week, was an international phenomenon and not explicitly UK centric. Something which you can be forgiven for not appreciating when listening to any news broadcast!
Where the UK specifically comes into play follows Friday’s mini budget from new chancellor Kwasi Kwarteng, proposing the biggest tax cuts since 1972, and sparking concern for investors in UK debt. The un-funded proposals called into question the UK’s financial credibility causing an already weak Sterling to weaken even further and Gilts, another barometer of UK economic performance, to also sell-off sharply.
Why does it matter? The Gilt market is particularly relevant to large Defined Benefit pension schemes, where managers use government debt to match their ongoing liabilities. Falling values (increasing yields) have meant that they have had to sell more to fund more – a problem compounded by their use of derivatives which magnified losses. This creates a spiral effect and consequently, forced many to sell an even greater amount of gilts and other assets to meet labilities and make margin calls, exacerbated the problem. On Wednesday, Long-dated Gilt yields rose above 5% – levels unheard off over the last decade – prompting concern.
Warning of a material risk to UK financial stability, the Bank of England decided on Wednesday to step in and provide emergency help to markets. Reversing their proposed Quantitative tightening – a programme to sell gilts and reign in inflation – they instead set out on a new £65bn bond-buying programme over the next thirteen weeks which helped stem losses in the immediate term and we await to see the more medium-term effects.
Despite the above, looking more broadly at financial markets (and although subject to change), earnings have remained resilient through the summer months and whilst economies are slowing, they are expected to remain at positive levels for 2022. One thing we are keen to stress to clients is that even in episodes such as September, it is not all negative and there have been areas that have benefited. For example, despite the S&P 500 falling 10% over the last month, UK investors have been insulated by the weakened Sterling which limited losses to just a 1.5% fall, and it is similar for other global equity. It is also worth reminding that within fixed interest, our portfolios held minimal direct gilt exposure anyway and this was a position we closed completely in May.
So where are we now? Well, whilst we would never look to explicitly call the bottom, our view as a committee is that expectations have again been too hawkish and that markets have oversold. Talk of interest rates hitting 6% next year seem overblown to us, especially in the context of higher energy costs and the shorter-term shake out in mortgage markets witnessed most recently. New Prime Minister, Liz Truss, and Kwasi Kwarteng seem committed to carrying on with their fiscal plans, which may seem at odds to monetary policy, and will continue to have implications for gilts and the currency. However, to our mind, the UK remains an attractive investment opportunity and one which we remain positive on over the longer term. One further positive of having a weaker Sterling is that UK businesses become even more attractive to overseas acquisitors.
Therefore, we continue to believe that remaining fully invested, via a diversified, long term fundamental approach will ensure that clients will fully benefit when markets recover. Should you wish to discuss your portfolio or markets more generally with your investment manager then please do not hesitate to contact us.
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