Quarterly Investment Newsletter: Autumn 2022

The third quarter of the year saw markets start to second guess central banks’ resolve to raise interest rates in order to combat inflation. Expectations of a change in monetary policy gathered momentum and caused a rally in global equities of over +11% in a five week period. Alas this proved to be a short- lived bear market rally as central banks, led by the US Federal Reserve, signalled their determination to stay the course with rate rises. By the end of the quarter equity markets had given up all of their gains and more, finishing with a loss of more than -5%. For a Sterling based investor this return was softened by the weakness of the Pound, particularly against the US Dollar, with returns being broadly flat for the period. Gilts, having suffered in the spring, continued to sell off significantly in the face of rate rises and a mini-budget which was not well received by markets.

Global inflation remained stubbornly high throughout the summer being driven primarily by energy and food prices. The cost of living pressures brought about by high energy prices in particular have led to a curious interaction between monetary and fiscal policy, where central banks are trying to slow growth to stop inflation becoming embedded in economies, whereas governments are stepping in to help households meet their basic bills. As ever, the lag between interest rate rises and their impact on the economy makes it impossible to know whether central banks will over-tighten and when they should cease raising rates. The expectation, given that central bankers fear inflation more than they fear a recession, is that we will end up with more hikes than necessary and the ensuing recession may be deeper than hoped for. For the US Federal Reserve, who lead the way with tightening policy, the strength of the US Dollar is a complicating factor which impacts many around the world, not least emerging market countries, and one which cannot be ignored despite them giving clear guidance on the domestic measures which will drive their decisions.

Despite central bank fears, markets remain optimistic that inflation will subside, and economists forecast that we are at or near the peak of price rises. These expectations are partly due to the base effect of energy price rises falling out of the calculation, but we can also look to the reopening of supply chains and Chinese producer price inflation as positives for the inflationary outlook. There are also recent indications that jobs markets, while still tight, are beginning to cool a little. Of course, the ongoing situation in Ukraine will continue to have an impact on commodity prices, and this remains an unpredictable element.

Inflation aside, there is plenty to keep market analysts busy. The UK’s new government attempted a mini-budget which was far from ‘mini’, and which was such a departure from fiscal policy of the last 15 years that it took markets by surprise leading inevitably to a fall in Sterling and a rise in the cost of borrowing for the UK. In Europe, solidarity within the EU is once again challenged as governments pursue divergent policies for dealing with the energy crisis, with wealthier countries hesitant to fund a common approach. And finally, in China, problems around the indebtedness of property developers continues to slow growth, and has knock on effects for local government finances and the banking sector.

At our September meeting the Investment Committee voted to maintain our neutral position in equities, and to retain the more defensive nature of the underlying holdings. We recognise the current strength of the US Dollar and therefore took some profit on unhedged equity holdings and moved to neutral in bonds.