A Look at Global Financial Markets 15.11.22
This Investment Strategy update aims to provide clients with a comprehensive picture of the global economy and regular updates on the current stock market and fixed income trends, to assist investors in making informed investment decisions. It is headed by Tom Elliott, deVere's International Investment Strategist, who produces regular updates on a wide range of topical investment issues. Please find below the update from 15th November 2022.
Market sentiment: A more positive mood amongst investors. Investors appear confident that the current stagflation problem affecting the major industrialised economies will be overcome, through decisive action from the central banks to tackle demand-driven inflation pressures. November’s U.S inflation data, released last week, showed a fall in headline and core CPI inflation, and appears to be evidence of Fed policy success. Global stock markets have rallied.
The U.S mid-terms have resulted in a set-back for Trump and the conspiracy theorists that threaten to undermine U.S politics, though the Republicans winning of the House of Representatives will stymie any new economic policy initiatives by the Democrats. Stock markets historically like stalemates in Washington, perhaps because they tend to mean no new economic or tax /spending surprises. Bloomberg’s John Authers has pointed out that since 1951, the S+P500 has regularly outperformed when a Democratic president has to work with a split, or a Republican-controlled, Congress.
Investors need to be patient. Investors waiting for the next economic cycle to start need patience. High borrowing costs, and weakening demand in the global economy, will hurt leveraged businesses and over-borrowed governments (as well as their tax base). There will, almost certainly, be more bumps in the road before we see a period of renewed economic growth, with low inflation, and a weaker dollar. Corporate earnings estimates continue to look vulnerable to downgrades. In the meantime, quality assets in relatively defensive sectors appear better bets than those that require economic growth.
Those with exposure to the U.K are likely to experience a higher tax burden, when Chancellor Jeremy Hunt announces its medium-term fiscal outlook on the 17th November. A ‘fiscal hole’ of 2% of GDP exists, similar to that which prompted Chancellor George Osborne in 2010 to launch a decade of fiscal austerity.
Given the already high levels of tax as a share of GDP, and the Bank’s warning of a prolonged recession, the outlook for U.K-based stocks is unappealing. As has been mentioned before in this note, the FTSE 100 index is excluded from this warning since it is largely an index of multinationals, with significant foreign earnings. This week’s announcement that the French stock market now has a larger capitalisation than that of the U.K, thanks in part to the success of its large luxury goods sector, highlights the advantages of a truly global portfolio.
Stay balanced! Financial history shows that a balanced portfolio, diversified by sector, geography, and asset class, will outperform any one asset class over long periods of time when adjusted for volatility.
The mid-terms leave the Fed in charge of the economy. Further U.S corporate tax hikes are off the agenda -to the relief of those companies that would have been hit. But so too so is the outlook for any further spending initiatives that may have eased the fall in real household incomes.
The political stalemate leaves the Fed as the sole driver of the U.S economy, with its relatively blunt tools of interest rates and direct interventions in the bond market.
The one certainty is that the debt ceiling will re-emerge as a problem next spring, with the Republicans unwilling to vote through an increase to the Treasury’s borrowing capacity. It is ironic -from a non-U.S perspective- that the Treasury needs the debt ceiling raised in order to pay for things that Congress has mandated.
The Fed talks tough, to the relief of investors. A fortnight ago the Fed raised its target rate by 75bps to 3.75%-4%, and the Bank of England raised its benchmark bank rate by the same amount, to 3%. The Fed said it is looking to slow the pace of monetary tightening, as it waits to see what the effect of prior interest rate hikes will have on the economy. It also suggested that investors had underestimated the final resting point of interest rates in the current cycle (the so-called terminal rate), which the market had then priced in at around 5%.
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This tough talk did not dent investor appetite for risk assets, as might have been expected. The explanation appears to be that investors expect an economic downturn, have priced it in to stock and credit prices, and if tough Fed action hastens the start of a new economic cycle, and fresh investment opportunities, all the better. What investors dread is a repeat of the on/off commitment against inflation that the Fed, and many other central banks, displayed in the 1970s.
Last week’s fall in core inflation, which had been the focus of the Fed rate hikes, will reinforce expectations that the Fed will decelerate its rate hikes from December. A 50bps hike is now expected.
The Bank of England takes a softer line, but for unpleasant reasons. In contrast to the Fed, the Bank of England suggested that the market was being overly-pessimistic on the terminal rate of the current interest rate cycle. Market pricing of the peak has come down from 6.25% (at the worst point during the Truss/Kwarteng debacle), to 4.8% But this, the Bank said, may be too high given the likelihood of a ‘challenging recession’ of possibly two years duration. The cut in real incomes, as wage growth lags behind inflation, and the Treasury tries to fill a £50bn ‘fiscal hole’ with take hikes and public spending cuts, will contribute to lower inflation.
U.K housing. Some saw the Bank’s comments as an attempt to talk down inflation and interest-rate expectations, and indeed two-year fixed mortgage rates did fall after the statement. This is important, since the U.K economy remains unusually sensitive to mortgage rates. Higher monthly payments, on top of large increases in energy and food bills, risk undermining the housing market. Lloyds Bank, a major lender to the housing market, recently announced a 26% fall in year-on-year profits primarily because of a £668bn provision for bad loans, mostly mortgages.
The good news for the U.K housing market is that new supply is weak, and restricted by structural issues. One of these is tough planning regulations. Another is the growth in population, which together with an increasing number of people living on their own, ensures strong demand.
U.S housing also under a cloud. Mortgage rate increases are less of a problem in America, since home owners tend to fix them for much longer periods than, say, in the U.K. But the U.S housebuilding sector is a big employer, and it relies on borrowing ahead of sales. When borrowing costs rise sharply, and sales slow due to deteriorating confidence, liquidity issues often emerge. As they are in China’s property sector. Forced selling by developers can follow, with consequences for property prices elsewhere. The lending banks, as in the U.K and continental Europe, are much better protected from loan defaults than they were in 2008/09, but we can expect to see loan loss provisions rise.
Gilts can take QT. Reassuringly for the Bank of England, and the gilt market, the Bank was able to auction off £750m of gilts at the end of October, as it unwinds its £900bn holding acquired through its quantitative easing (QE) program. It is the first major central bank to pursue quantitative tightening (QT) in this form, rather than to simply not re-invest the proceeds of maturing bonds and the coupons. It demonstrates a more confident gilt market than a month previous, thanks in large part to the reversal of the Truss/Kwarteng budget, and the expected fiscal tightening to be announced on the 17th November by the U.K Treasury.
Sterling. The pound has strengthened over the last week, as the likelihood of just a 50bp rate hike in the U.S in December has increased. No great weight should be attached to this, sterling is unlikely to rally much given the weakness of the U.K economy.
Stay well!
deVere's International Investment Strategist
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2yNavigating the volatility of the global economy is the primary concern for investors. Thanks, Oliver, for offering a valuable look at what the global financial markets look like right now.