Investment Update: November 2022

INVESTMENT UPDATE NOVEMBER

September was an extraordinary month for markets for many reasons. The US equity market staged a good recovery, although this belies the fact that many of the technology companies that make up the main index struggled in the face of poor results. Whilst the S&P 500 was up nearly 8%, the technology rich NASDAQ index’s return, was more muted at 1%, this being a reflection of the higher priced growth stocks being more susceptible to higher interest rate s and an economic slowdown. For sterling-based investors, the returns from US assets were dampened by a recovering pound, which continued to rally from the politically induced lows, finishing up 3.3% against the dollar.

The latest earnings reports from US larger companies have been broadly positive at headline level, although revenues are trending lower. This has fed through to valuations although still not cheap by historic levels if one includes the 5 technology giants such as Microsoft and Apple. Beneath the surface however, many US companies are now trading at attractive valuations and exporters may be boosted further as the US dollar weakens into 2023 in direct relation with easing interest rate policy.

In the UK, politics, economic and monetary policy have been centre-stage globally. The rapid policy changes led to an unprecedented level of volatility in the UK Gilt market, which is shown in the chart of a long dated gilt tracker fund below (despite what the press reported the movement in sterling was relatively small). This in turn led to problems for pension funds who were using leveraged strategies linked to the gilt market. In short, whilst the asset class had been steadily declining for some time, it was the extreme short-term volatility caused by the governments fiscal policy which left many pension funds scrambling to sell assets to cover their losses in what should be a lower risk asset class.

Fortunately, the subsequent reversal of policy and eventual regime change, led to the gilt market ending up on the month. Indeed, yields that, at 4.9%, were higher than Italy’s for a brief period have now settled comfortably below the 4% level and lower the US now. Despite the political issues, currency gyrations and high inflation, the UK equity market is still the best performing of the major markets this year. Inflation remains stubbornly high and monetary policy reflects this, but relatively low valuations versus the rest of the world are starting to make UK equities seem attractive. However, visibility on the direction of travel of the economy is required before which area of the market to target. Meanwhile exposure to dividend paying companies has been maintained, particularly in our managed fund.

In Europe, As is the case elsewhere “hard” economic data is holding up relatively well. But “soft” (sentiment-based surveys) are pointing to a steep downturn ahead. But here too, the downturn will be muted by fiscal support (for instance Germany has unveiled a EUR 200bn programme to aid households) and a sharp decline in gas prices. Cognisant of the risks to growth, the ECB has hinted at a slower pace of rate rises in the months ahead. While recession is more likely here than in other regions, this is already largely discounted. The Russo/Ukraine war appears to be bedding into an attrition phase during winter. Of course, this geopolitical risk impacts all major markets.

China was the weakest major market in October, as investors reacted to the significant shake-up of the politburo in the 20th National Congress. President Xi has been given a third term in office, and by removing potential dissenters, now has virtually complete control of the government. The lack of checks and balances could lead to poor decisions going unchallenged; the focus on the zero-Covid policy is a case in point. Continued rolling lockdowns combined with weaker external demand will weigh on economic growth.

As ever, what happens in the United States will set the scene further afield. The Federal Reserve remains the de facto global central bank and the US dollar the global reserve currency. It is expected that US rates will rise 0.75% in November, thereafter a rise of 0.5%, followed by at least a further 0.25% early in 2023. Interest rates in US are likely to peak around 5.00% and will effectively sit on top of inflation as it falls. There is likely to be a pause before the Federal Reserve finally pivots and begins to gradually ease monetary policy later in 2023.

Equities are a super-efficient asset class and will likely begin to move positively ahead of time. Of course, this remains a dynamic situation and things can and do change. In the intervening period we expect to see more bear market rallies and reversions – beware of “fool’s gold”. Economies are likely to continue slowing towards recessionary territory which historically has been an emphatic if somewhat brutal methodology by which to kill the inflation dragon – as shown in the chart that follows. We note the rapid slowdown of the US residential housing market, clearly linked to higher borrowing costs and increasingly less certain employment tenure.

Source: The Macro Compass

Portfolios remain unaltered during the month with elevated cash levels and a defensive stance with higher levels of exposure to the US dollar. This positioning has benefitted performance in recent times. So, in conclusion, this remains a complex market and one where global economic synchronicity is less obvious than it once was. There remains a vivid focus on markets and their leading indicators. Progress towards a resumed upward path is certainly underway, albeit at an early stage but with some positive indicators now detectable.

Rockhold Asset Management, with contribution from Alpha Beta Partners and Marlborough, November 2022