Political turmoil tests UK markets, but calm is swiftly restored
It was another tumultuous month in the UK. As October wore on, it became increasingly clear that a series of policy U-turns following the fallout from the mini-budget would not be enough to save the credibility of the new leadership. One by one a fatal blow was dealt, first to the new Chancellor Kwasi Kwarteng, followed by the Prime Minister Liz Truss herself, amid chaos in the markets that saw gilt yields spike above 5% at one point. The Bank of England was able to steady the ship, intervening to prevent a potential collapse in defined-benefit pension plans. Calm was finally restored with the installation of Rishi Sunak as the latest occupant of number 10, in a selection process that lasted a mere four days.
Big tech stumbles as the earnings slowdown bites
The earnings season in the US was mixed. Netflix and Bank of America announced strong numbers, along with leading companies in healthcare, defence and energy. However, these were offset by disappointing figures from a range of other big tech bellwethers including Alphabet, Microsoft, Facebook parent Meta and Amazon, sending this sector sharply lower. The impact of the economic slowdown was increasingly evident, with a deceleration in the overall growth rate of earnings to around 1-2%.
While the US Fed maintained its hawkish rhetoric on interest rates, cracks in the narrative were beginning to appear elsewhere. The Bank of England's deputy governor indicated that market expectations for the future direction of interest rates were currently too high, particularly given the outlook for greater fiscal constraint under Prime Minister Sunak. Authorities in New Zealand, Canada and Europe echoed this message, all signalling that they expected the future pace of rate hikes to slow, causing a rally in bonds worldwide.
Xi consolidates power as investors flee Chinese equities
While calm was restored in the UK, volatility picked up elsewhere. In China, equities sold off sharply as President Xi Jinping was confirmed for a third term and was able to greatly consolidate his political power within the party. Investors were dismayed as he defended China's zero-covid policy, stating that it would remain in place for the foreseeable future. The economy had paid a heavy price for continued lockdowns, contracting in the second quarter by almost 3%.
Equities closed higher across major Western markets, recording gains of between 3% and 4%. Asia and emerging markets, however, closed lower, led by a fall of 18% in Chinese stocks. Under Sunak's leadership the UK was likely to see a much more fiscally conservative government, and this brought immediate relief to bonds, equities and sterling, all of which were trading back at levels prior to the crisis.
The macro backdrop remains challenging but much is already priced in
The macro-economic environment remained challenging, with headwinds from both high inflation and slowing growth, the latter being squeezed by a combination of higher interest rates and the rising cost of living. The US remained the most resilient among major Western economies, but even here multiple leading indicators were suggesting that the cycle was turning down. Lagging indicators such as jobs and inflation should soon start to follow.
The episode was a timely reminder that, while it is easy as investors to get caught up in short-term news flow, political affairs are not generally a driver of long-term returns. Recent events did demonstrate, however, that there was limited scope for policy change: any supply-side revolution would have to wait until the economy and its fiscal position were on a more solid footing. This applies to most Western nations whose fiscal positions deteriorated following the cost of the pandemic.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
Tech stocks deflate while patient UK investors collect their dividends
Tech stocks had been in an unrelenting downtrend since peaking in February 2021, following an unprecedented boom in demand for their services during the pandemic that drove share prices to extreme highs. Share prices had since been savaged, as it became clear in hindsight that valuations should not have been priced as if these exceptional conditions would continue for ever. This was the key reason we had sought to minimise exposure to this sector in recent years. News flow was extremely positive at the time, but valuations were approaching bubble levels, suggesting that risks were rising. When the cycle turned down, only the most nimble of investors made the exit in time. A large portion of the valuation premium in this sector had been erased by falls over the past year, but it might take some time for investors to return.
The best long-term driver of returns is the price you pay. Buying assets cheaply while they are out of favour and holding over the medium term is generally a good way to generate low-risk returns. It does, however, require patience. Investing in the UK has tested the patience of even the most stoic. Equities had been cheap and trading at a considerable discount to other developed markets for some time. A series of setbacks, from Brexit uncertainty to the pandemic, had been followed by the return of inflation, rising rates, the prospect of a recession and a series of political crises. The value had not yet been realised. Throughout this period, however, UK companies generally churned out a strong dividend yield (with a brief hiatus during covid). Dividends were accruing at a rate of 4.2% per annum while we waited for the clouds to clear. Compared to more glamorous areas such as US tech, slow and steady wins the race.
The best long-term driver of returns is the price you pay.
Corrections are an unwelcome but normal event over time, as markets often get ahead of themselves and need to reset periodically. The decline through 2022 felt worse following on from years of relatively smooth returns generated during the exceptional environment of quantitative easing and low rates. The UK economy, along with Europe, was forecast to remain in recession throughout 2023. This was not surprising news: much of the bad news was already reflected in prices, as markets had now had almost a year to adjust. A bear market was, however, unlikely to last that long, as markets tend to bottom and recover ahead of economic data. An attractive entry point was anticipated in the not-too-distant future.
Diversification is key to riding out these storms, and our standard portfolios have proven much more robust than their respective benchmarks. Current risks remain finely balanced between high inflation and weaker growth, and our portfolios are structured to reflect either outcome.
Defensive equity exposure
Overall equity exposure is focused on defensive areas such as income funds that own companies with strong cashflow and resilient balance sheets. These should provide relative safety as the growth outlook slows. We are happy to keep risk low and accumulate dividends during this period of uncertainty.
Inflation-resilient assets
Portfolios hold assets that should prove relatively robust in, and even benefit from, a higher-inflation environment: index-linked bonds, infrastructure and renewables, along with real assets such as gold bullion, precious metal stocks and commodity equities.
Awaiting an attractive entry point
The UK economy, along with Europe, is forecast to remain in recession throughout 2023. Much of this bad news is already reflected in prices, and a bear market is unlikely to last that long. Markets tend to bottom and recover ahead of economic data, and an attractive entry point is anticipated in the not-too-distant future.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
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