The Federal Reserve Bank and the Bank of England announced steep interest rate hikes last week amid warnings that next year’s economic backdrop would be testing. Both Fed Chair Jerome Powell and Governor of the Bank of England Andrew Bailey signalled that monetary tightening would continue until inflation was tamed. However, Andrew Bailey suggested that the UK’s tightening programme would be less aggressive than that of the US – given the continuing fragility of our economy.
As the Bank of England implemented its biggest single increase in interest rates in 33 years, it warned that the UK was facing its longest recession since records began. A “very challenging two-year slump” and unemployment “nearly doubling by 2025” are what lie ahead, according to the central bank. Andrew Bailey justified the decisive action taken last week by saying that it would result in a better longer-term outcome.
The Bank of England is the first major central bank to announce quantitative tightening: it is selling some of the bonds it bought in past crises in a bid to keep interest rates low. It currently holds some £850 billion of gilts purchased as part of previous quantitative easing programmes, which now need to be unwound. Furthermore, the bank sold £750 million of short-term government debt in an effort to cut back on its balance sheet. This marks the reversal of more than a decade of successive waves of QE (implemented in the wake of the global financial crisis, the 2016 Brexit referendum and the start of the pandemic).
After several weeks of government turmoil, we are now awaiting Jeremy Hunt’s budget – which has been put back to 17 November. The word on the street is that he will target a 50/50 split between spending cuts and tax rises. It has also been reported that Mr Hunt has asked officials to look into raising the dividend tax rate, as well as cutting the tax-free allowance for dividends. In the meantime, both the Prime Minister and the Chancellor have refused to commit to maintaining the triple lock on pensions, signifying that millions could face real-term cuts in April.
Liz Truss’s commitment to spend 3% of national income on defence by 2030 is also under review. And Boris Johnson’s promise to raise benefits in line with inflation looks set to be broken. There are also likely to be cuts in infrastructure spending: there are now question marks hanging over projects such as the HS2 rail link between Leeds and Manchester and the Sizewell C nuclear plant.
With interest rates at their highest levels in three decades and households having to deal with rising food and energy costs, it is no surprise that house prices are falling for the first time in over a year. The turmoil created by Kwasi Kwarteng’s mini-budget has hit housing sales, according to Nationwide. In October, prices fell by 0.9% month-on-month – the first decline in 15 months.
A significant fall in UK property prices next year could conceivably leave almost a fifth of young homeowners living in properties worth less than their mortgage. The picture also looks bleak for potential buyers – borrowing costs have soared as inflation sits at a 40-year high. Those seeking to rent will not be spared either – landlords are likely to pass on higher mortgage costs to their tenants.
As the war continues in Eastern Europe, Joe Biden has indicated his intention to impose higher taxes on oil companies that reap windfall profits without reinvesting in production. But unless the Democrats do particularly well in the forthcoming mid-term elections, he is unlikely to be able to convert this intention into legislation.
Global markets are struggling as they try to come to terms with inflationary pressures, statements from various central banks about the challenges that lie ahead and the continuing war in Europe. However, historically the S&P 500 Index has reacted well to mid-term elections in the US (going back as far as 1942). And although September is by far the worst month for markets, November and December tend to be significantly kinder: end-of-year “Santa Claus rallies” often bring joy to investors.
The world is in a state of upheaval and it has been difficult to make judgement calls. A clear path through the current complexities has yet to emerge. And there is every chance that the impending recession will bring with it further difficulties. The good news, however, is that we appear to have passed “peak panic”.
Recent corporate earnings season transcripts from numerous CEOs and CFOs suggest lower input prices for both commodities and raw materials. And there is evidence that the labour market is not quite as tight as it once was. All of this offers corporates, traders and investors a glimmer of hope.
Although the vast majority of active long-only fund managers have found themselves in negative territory, tactical traders have enjoyed some measure of success in 2022. And a scattering of funds have managed to buck the trend – they have done so by having a higher level of exposure to value stocks. Or… they simply have pricing power.
Following a prolonged period of outperformance by growth stocks (dating back to the 2008 global financial crisis), there are now strong signs that the tide may have turned in favour of value investing. This comes in the wake of an extremely swift and steep equity market downturn (generated by the pandemic and fears of a hard economic landing).
Value stocks by definition trade at lower multiples of earnings (or book value) than growth stocks. And since they tend to be traded lower than market averages, they appear more attractive during periods of turmoil.
Nevertheless, we continue to advocate diversifying within a global portfolio, rather than trying to second-guess the market. That’s why we have both growth and value combined with income providers and innovation. This ensures a balance of style, total return and originality.
In the UK, the FTSE 100 Mid-Cap indices rallied by around 3.5%, and by 1.7% by mid-session on Friday. Meanwhile, the yield on the two-year Treasury – which is particularly sensitive to short-term monetary policy decisions – reached its highest level on Thursday since mid-2007 (4.67%). Wall Street remained volatile as the Federal Reserve Bank’s actions were absorbed by traders and investors. Elsewhere, Chinese stocks had a good week. Gains were registered on hopes that Beijing would change its long-standing zero-Covid policy, while industrial metal prices skyrocketed, aided by positive sentiment regarding China and the weaker dollar.
Upheaval and unrest continue, but everything… everything is time-limited.
