Tougher rhetoric from central bankers as prices and wages rise
The persistent fall in unemployment and further signs of rising prices prompted tougher language from leading central bankers during September. Share prices recovered from a mid-month sell-off to end barely changed, while major bond markets fell by around 1%. All major markets then saw further losses in early October.
Rate rises across the globe, with the Fed the most significant
Several central banks raised interest rates during the month. The most significant was the expected 0.25% rise in the US. The largest was a further 6.52% by Turkey, closely followed by a 5% increase in Argentina's rates, taking the benchmark to 65%. Jerome Powell, Chair of the US Federal Reserve, warned that he still viewed policy as "accommodative" and that they may need to take rates above the mythical "neutral rate", which he deemed to be a long way off. This was in stark contrast to investors' reading of the earlier statement accompanying the rate rise, and pushed 10-year Treasury bond yields to 3.25%, their highest in seven years.
Mario Draghi, President of the European Central Bank, commented that while measures of underlying inflation remained generally muted, domestic cost pressures were strengthening and broadening. Japanese shares bucked the trend, rising nearly 3% in sterling terms over the month.
Italy's budget and the lack of Brexit substance
The Italian coalition government proposed a budget representing 2.4% of GDP, outside EU guidelines and significantly higher than previously indicated. Subsequent statements claiming that the deficit would fall to 2.2% and 2.0% in 2020 and 2021 respectively were based on some fairly heroic growth assumptions. This pushed Italian 10-year bond yields above 3.5% and hit domestic banking shares.
Brexit continued to dominate UK headlines, though still lacking in substance. Theresa May showed anger and defiance after being humiliated by EU leaders, which, combined with some embarrassing dancing at the party conference, helped stave off any leadership challenge for now. Bank of England Governor Mark Carney was widely misquoted as warning that a no-deal Brexit would wipe a third off house prices.
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
US divergence from the rest of the world reaches historic extremes
Whatever one's view of the president, Donald Trump was having some success at making America grow. The economy was expanding with more conviction than other developed markets, and this was reflected in the divergence between record-breaking US stock markets and the rest of the world, which had reached historic extremes. Unfortunately, the combination of a strong dollar and rising US rates was particularly painful for countries in Asia, Latin America and Africa that had relied heavily on dollar-denominated debt.
In the developed world, monetary tightening was now a reality. The US Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England had together injected an average of $1.2 trillion a year into the global financial system. This stimulus peaked at $1.7 trillion in 2016, but the reduction in bond-buying had gathered pace over the preceding two years and was set to fall to minus $500 billion in 2019, as the ECB halted bond purchases and the Fed cut its portfolio by $50 billion a month. This came at a time when the US Treasury needed to issue a substantial increase in bonds to fund the president's tax reforms.
Politics would be to the fore over the coming weeks. Italy would discuss its proposed budget with the EU, where the Italians had vowed not to back down, though the EU could not be seen to condone actions transgressing its deficit rules. Around the same time came the deadline for the UK and EU to agree a Brexit deal. Also fast approaching were the US mid-term elections, which could determine the future direction of policy.
The divergence between record-breaking US stock markets and the rest of the world is now at historic extremes.
Bull markets tend to outlast rational analysis. For this reason, we have been reluctant to reduce our overall exposure too aggressively. Instead, we have mitigated risk by avoiding inflated areas and gradually increasing exposure to value and defensive stocks.
Underweight fixed interest
We remain underweight fixed interest, preferring equities, property and alternative investments. Where we do hold fixed interest, we mostly use funds that have limited exposure to rising interest rates.
Patience on emerging markets
Emerging markets were at a significant valuation discount, but we expected to see even cheaper levels as Fed tightening and dollar strength continued to bite. Longer term, valuations always speak for themselves, but we were waiting for more extreme levels for an entry point.
Favouring value over growth
We avoided inflated areas such as technology and high-priced growth stocks, preferring more out-of-favour markets such as Japan and the UK, while gradually increasing exposure to value and defensive stocks.
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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