The past week has been yet another mixed one for the markets. In the US, the latest corporate earnings numbers have been published and the labour market remains buoyant. This suggests the Federal Reserve Bank could well continue to raise interest rates – at least until the end of this year, and possibly even into the early part of 2023.
In the UK, the political turmoil continues. On Wednesday of last week, Liz Truss asserted that she was a “fighter, not a quitter”. On Thursday, she recognised that she could not deliver on her mandate and quit, establishing a new record in the process as the shortest-serving prime minister in British history. On Friday, the starting gun was fired on the fourth Conservative Party leadership campaign since the 2016 Brexit referendum.
One of Truss’s final acts as PM was to appoint Jeremy Hunt as Chancellor. She then watched him all but dismantle that contentious “mini” budget. That may have brought a measure of calm to the UK bond and currency markets. But it sealed her fate as prime minister.
The rules and deadlines for this latest leadership campaign were hastily agreed in a bid to shore up support for the government, prevent further resignations and avoid embarrassing mistakes. In the end, the campaign was mercifully short.
Former Chancellor Rishi Sunak will formally take over as prime minister from Liz Truss imminently, meaning that she will have served a mere 50 days in the job.
Sunak, the former chancellor who came second in the leadership contest against Truss in the summer, had already secured the backing of more than half the parliamentary party by Monday morning.
In her statement, leadership rival Penny Mordaunt said: “These are unprecedented times. Despite the compressed timetable for the leadership contest, it is clear that colleagues feel we need certainty today. They have taken this decision in good faith for the good of the country”.
So, what about the “good of the country”? As far as the UK markets and sterling are concerned, there is every hope that the new Sunak-led government will be eminently acceptable – and that he will be able to form a creditable cabinet and get things back on track. Indeed, sterling responded favourably to the news of his win.
The Bank of England had already helped restore some order to the gilt market by implementing a temporary target bond-purchase programme. This calmed the waters after a rollercoaster ride for pension fund providers and individual investors.
Meanwhile, Labour still has a 36-point lead over the Conservatives, emboldening Sir Keir Starmer to call for a general election. As things currently stand, that would spell electoral wipeout for the Conservatives.
If the new Prime Minister is able to reunite the party, he could have as long as two years to restore some of its credibility.
But the consensus view is that the UK economy is still in something of a tricky place. A challenging blend of gloomy fiscal policy and looser monetary policy is what lies in store for us.
In its latest World Economic Outlook, the International Monetary Fund has indicated that it expects growth to slow to 0.3% in 2023 (down from 3.6% this year). It also expects global GDP growth to fall to 2.7%.
September's double-digit inflation figures were extremely frustrating for the Bank of England and households more widely, given that some of the pressure had appeared to be easing on energy prices.
Soaring food prices – their biggest jump since 1980 – have pushed the increase in the cost-of-living back up to a 40-year high (10.1%).
Following a series of external shocks, British incomes are buying less than they did 12 months ago. And in real terms, they are buying less than they have done at any point since the beginning of the Blair years in 1997.
However, a recent speech delivered by Ben Broadbent – the Bank of England's Deputy Governor for Monetary Policy – appears to suggest that market expectations for the progress of interest rates are too high. Broadbent indicated that interest rates are nearing their high in this current tightening cycle and that bond yields are set to fall. This would alleviate the discomfort that mortgage holders, lower-paid workers and British households are currently suffering.
The Federal Reserve Bank, however, is adamant that higher interest rates have done very little to tame inflation so far, and that further increases will be needed. Nearly every asset class this year has delivered miserable returns, and so global investors have flocked to the US dollar, giving it double-digit percentage increases against a basket of other currencies.
A strong US dollar makes it difficult for people who borrow in dollars to service their debts and operate in the foreign exchange markets. Indeed, the Japanese yen has already dipped below ¥150 against the dollar for the first time in more than three decades. And in the UK, sterling has fallen dramatically against the greenback (although it is edging up again on the back of Sunak’s win).
In Europe, European Union leaders have once again failed to reach any sort of agreement on a cap on gas prices. The energy crisis is clearly taking its toll and is likely to get worse throughout the winter months. Rolling blackouts are already hitting parts of Ukraine after Russian drone attacks targeting vital energy infrastructure knocked out at least 40% of its power-generating capacity.
Russian tactics have changed dramatically in recent weeks: both sides are now condemning unsubstantiated claims of “dirty bombs” being used. This current phase of the Russia-Ukraine war appears to be threatening the wider world with a radiation disaster.
Given the global backdrop, even the smallest nugget of good news should be seized upon… and so we celebrate the fact that the price of crude oil and several major agricultural products have drifted back down in recent weeks. Similarly, many of the worst shortages and supply chain challenges have been resolved, which could soon start helping to bring inflation down.
Nobody is saying that we are out of the woods. And yet… the financial markets seem to be in the process of finding a short-term bottom. Any good news from now on is likely to be warmly welcomed by bruised investors. Let’s not forget that we are entering the two best months of the calendar year when it comes to performance.
We cannot predict the end of a bear market and the beginning of a bull market. But bull markets are longer and more valuable when it comes to stock market returns. Bear markets are painful and test our faith as investors, but they should not distract us from our long-term objectives. In short, difficult and counterintuitive though it may seem, we should avoid panic and disorderly selling, and instead view times such as these as buying opportunities.
