Neil Birrell, Premier Miton’s Chief Investment Officer and lead manager of the Premier Miton Diversified Fund range, gets back to the topic of the year so far; rates, both inflation and interest, as well as having a look at how markets reacted to the changing backdrop.
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It was too good to last
Last month I rather enjoyed not writing about the global economic backdrop as the central bankers in the US, UK and EU took August off, so there were no changes to interest rates, however, they got back to their desks in September and didn’t we know it!
What did you expect them to say?
The US Federal Reserve (Fed) and the Bank of England (BoE) left their interest rates unchanged, whilst the European Central Bank (ECB) increased theirs by 0.25%. None of that was a shock, although the BoE decision was a close call, which was reflected in the Monetary Policy Committee’s 5-4 vote. The one common feature was the comments made by the banks alongside the decision on rates.
Firstly, though, the topic of the day, week, month, year and what feels like forever; inflation. It is a bit of a fool’s game to forecast inflation, it is very difficult to do so accurately, but when investing we do need to have some view on how it might be behaving. It is also brave to predict economic or financial market outcomes, but I am willing to go as far as; it does appear that inflation has peaked in the major economies and may well continue to fall from current levels. However, it is too early to call the battle won and there may be short term upward spikes, for example, the near 8% jump in the oil price through September could pose a threat.
Overall, that also appears to be the view of the Fed, BoE and ECB, however, they will have many econometrists and economic models to provide support for their views and decisions.
So, whilst they talked about the improving news on inflation and relatively resilient economies, they, particularly the Fed, also cautioned against expecting interest rates to fall. Uncertainty prevails and although it seems investors are surprised by the “higher for longer” language being used by the central banks and are, apparently, a little unnerved by it, they should not be surprised. As we approach the peak in the interest rate cycle, it is hard to imagine central banks taking their foot off the brake and suggesting that rates will start to fall. They have to talk a tough game as well as play it.
In my view, how long interest rates stay high is more important than how high they actually go. The longer the period, the greater the pain for consumers and corporates alike, so that is the risk; too long at high levels means a greater risk of a sharp economic slowdown. We remain on the tightrope we have been walking for some time, just further along it.
That’s what spooked financial markets
Bond markets usually react badly to expectations of rising interest rates and rising inflation and the converse is true as well. Although the news is positive; inflation falling and interest rates not rising, expectations were disappointed somewhat. As a result the prices of US government bonds fell, meaning the yield (which is the price of the bond divided by the interest rate it pays) rose to levels not seen since before the 2008 global financial crisis. It wasn’t all bad news though, the interest rate story in the UK was taken more positively, as a further increase had been much more likely, so bonds issued by the government and companies barely moved.
It was a similar picture in stock (equity) markets; most world markets were lower, notably, and following on from the note I wrote last month, the large US technology and communications companies, such as Apple, NVIDIA and Amazon, whose share prices have been doing so well, saw weakness in their share prices.
Some of this was driven by the moves in bond markets, but more particularly that “high for longer” would result in slowing economic activity, possibly recession and therefore a knock-on adverse effect on company profitability would ensue. The result would be that the valuations of company share prices would therefore be more expensive, which is not a favourable outcome. Hence weaker stock markets.
What I said
If you did look at this note last month you would have read that I believe there are areas of stock markets that are overvalued, which include many, but not all, of the big US technology companies alluded to above. But also, there are areas of great opportunity, with the UK being at the forefront of those. It was noticeable in September, when everything else fell, that the UK stock market was up.
Part of the reason was that the oil price was strong, so BP and Shell’s share prices jumped as a result and the oil sector makes up a large part of the UK stock market. However, there is little doubt the UK looks good value by international comparison.
Furthermore, the belief was that interest rates here were going higher anyway, so expectations were not dented, the inflation data released in September in the UK was better that hoped and the economy remains more robust than I, for one, had thought. All in all a decent month for the UK relative to the rest of the world and I haven’t been able to say that for a while.
The last word
As we roll into the final quarter of the year many of my fund manager colleagues at Premier Miton are wishing it away. 2023 has been a tough one for investing and we hope that 2024 might bring some greater clarity. We all feel there are great opportunities across asset classes; bonds, equities, property companies and others.
We are at a point in the inflation, interest rate and economic cycle where asset prices are likely to be particularly sensitive to economic news flow and volatility should be expected. But that in itself provides opportunity, so maybe the rest of the year could be quite interesting.