Premier Miton’s Chief Investment Officer
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The last few weeks have provided the usual flurry of economic data, but, rather contrary to the recent past, it has been rather positive. This was particularly the case for the UK, which was even more unusual. In the middle of July, the announcement of the Consumer Price Index for June showed that the rate of inflation had slowed faster than expected and was back to a level not seen for 12 months.
Later in the month the IMF (International Monetary Fund) upgraded its forecast for global economic growth for this year. They had been notably negative on the prospects for the UK previously, but that view changed and they moved to predict modest economic growth in the UK rather than a contraction in the economy.
Whilst this is an improved outlook, we should remember that headline inflation in the UK is still running at 7.9% and core inflation, which strips out food and fuel, as well as some other goods, is running at 6.9%. It was therefore unsurprising that the Bank of England opted for another 0.25% on interest rates at their meeting on 3 August.
In the accompanying statement, the Bank commented that interest rates would carry on up if needed. But it does feel like we might be at or very near the peak. However, how long interest rates remain at the peak is probably more important than the rate itself. The longer the period, the longer the pain for consumers and companies alike.
On the other side of the pond and over the Channel
Elsewhere, the economic news is improving. I have previously written about the concept of “policy lag”, which is how long it takes for changes in interest rates to take full effect on inflation and the rest of the economy. Simply, we do not yet know the impact of all the increases so far. It has been a fine balancing act for the central banks, such as the Bank of England, in their attempt to beat inflation, whilst avoiding recession in the economy.
As it stands, it looks like the US Federal Reserve Bank might be pulling off what few people thought it could, getting inflation down to acceptable levels whilst keeping economic growth robust. The latest data showed that the US economy grew more than expected in the second quarter of the year and inflation is at the lowest level for 2 years. Of course, given what I said above, that cannot be taken for granted just yet, but interest rates do look like they may well have peaked on the other side of the pond, after the 0.25% increase in July.
Over the channel, it is not quite as clear cut. Inflation remains an issue and the European Central Bank (ECB) may have to put interest rates up further after matching the move in the US in July. There are two more inflation data releases before it meets again in September to discuss interest rates again, so things will be much clearer then.
Overall, there is room for optimism on the economic outlook, as we move through the cycle. But we are not out of the woods yet!
Movers and shakers
If you will forgive me, I am going to copy and paste here, something I wrote in a summary of market moves in July, as I think it does bear repetition.
Financial markets have largely been driven by macroeconomic data for some time now, certainly since the advent of the COVID pandemic and arguably since the global financial crisis in 2008. By that I mean the prices of bonds, equities (company shares) and other asset classes have reacted to data on inflation, employment, economic growth, interest rates and similar factors, rather than, for example a company’s share price being mainly impacted by its profitability or business conditions, otherwise called “fundamentals”.
Markets in different asset classes have moved quickly and sizably, in other words they have been volatile as investors buy and sell in reaction to data and news flow. This takes place across large elements of the different asset classes. July proved to be a microcosm of that feature.
To give an example of that, the UK’s FTSE 250 Index is made up of the next largest 250 companies below the FTSE 100 Index (the largest 100). It contains a number of property companies and investment companies and is often considered to be reasonably reflective of the UK economy and stock market. The index started the month at 18417 and fell to 17916 (a fall of 2.7%) before rising to 18618 (a rise of 3.9%) the day before the UK inflation data was announced. The positive inflation data and resulting moderation in expectations for interest rate increases led to the FSTE 250 Index jumping to 19322 on the day (a big jump of 3.8%). It ended the month very slightly lower.
I could give many examples of big moves in a short space of time like that, in many stock markets and bond markets around the world over the recent past. It makes investment decision making tougher, but very importantly, means that focusing on the long term is crucial. It is easy to get whipsawed in the short term and that can be expensive. It also shows that there are differences within asset classes. The FTSE 100 Index, which is much more international by nature, only rose by a little more than half as much as the FTSE 250 Index.
The Apple of our eyes
I rarely write about individual companies in this note. But I think it is worth commenting on Apple, the largest company in the world. First of all, it is a great company, it’s not possible to reach such great heights otherwise. But the company announced on 3 August that it had suffered the third straight quarter of declining sales and predicted similar for the current quarter, which would be the worst run of sales declines in 20 years.
We shouldn’t feel too sorry for the company though, as total revenues came in at $81.8 billion for the three-month period. However, Apple is one of the much talked about (including in these notes) large US technology and communication companies that have driven the US stock market higher and higher, leaving the vast majority of other companies‘ share prices lagging. Not only has the share price risen, but it has also become more expensive (or valued) relative to its history and the rest of the stock market. It is a similar story for those other companies, which include Amazon, Alphabet (Google) Meta Platforms (Facebook) and Netflix, amongst others.
The point is, for these companies’ share prices and valuations to be maintained they need to keep growing and meeting investors’ hopes and expectations for that growth. As Apple is demonstrating, no matter how good and big you are, that can be a difficult goal to achieve. Therefore, again as I have said before, there must be a risk of their share prices coming under pressure.
The final word
Predicting the future is best left for Nostradamus, but as fund managers we do need to have a view of what we think the future might hold. Since the COVID pandemic that has been easier to do at times than others. As we move through the economic cycle and get more clarity on the prospects for inflation, interest rates and economic growth, that should allow us to take stronger views on the expensiveness or cheapness of financial markets and, more importantly, the individual bonds, equities and other investments that make up those markets.
Maybe then we can all play at being Nostradamus.