Neil Birrell
Premier Miton’s Chief Investment Officer
For information purposes only. Any views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Investing involves risk. The value of an investment can go down as well as up which means that you could get back less than you originally invested when you come to sell your investment. The value of your investment might not keep up with any rise in the cost of living.
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Peak interest?
You may have noticed that the title of this insight note refers to more than one “peak”. That is simply because it is unlikely that the policies being adopted by central banks over the rest of this year will be harmonised and could well send interest rates in different directions in different regions.
The big one
The US is the largest, most important and most influential economy in the world and all eyes and ears are focused on the actions and words that are coming from its central bank, the Federal Reserve (Fed). It moderated the scale of interest rate increases at its last meeting on 3 May, putting interest rates up by 0.25% to 5.25%, getting it back to the level it was prior to the global financial crisis, all those years ago.
There would have been two main reasons for slowing the scale of the rate increases. Firstly, there are signs that inflation is being tamed. The Consumer Price Index (CPI) has been consistently providing the evidence and now stands at less than 5%. Secondly, the Fed will still be wary of the problems in the regional banking sector and conscious of introducing any more stress into the banking system.
However, the Fed’s statement at the time of the announcement did point out that future CPI data would dictate policy and cautioned against any expectation that interest rates might be coming back down any time soon. This is where a conflict lies, as financial markets are, in fact, expecting that to happen.
I think there is a good chance they will be disappointed, inflation must be beaten, even at the risk of keeping interest rates higher for longer and causing recession in the economy. However, it may well be that we are at the peak of US interest rates.
The odd one
European governments and the European Central Bank (ECB) were trying to generate some inflation through the 2010’s to help stimulate economic growth, although they were unsuccessful. However, that problem has reversed and just as it has elsewhere, inflation has become a problem. The ECB also put interest rates up by 0.25% at the start of May, however, the news on inflation is less good than it is in the US and there is a good chance that the interest cycle has a little further to go.
The problem child
The CPI in the UK remains in double digits and hitherto has not shown much sign of budging. The Bank of England is painting a rosy picture when it comes to the short- and medium-term outlook for the economy. In my view, a little too rosy, and it is not out of the question that the base interest rate needs to rise to 5.0% from the current 4.5%, and that could mean more pain for the economy than is currently predicted.
Same old
It does feel like the battle against inflation has been on the go for some time. Raising interest rates is a blunt weapon, it remains very difficult to predict the impact of the increases we have seen so far. Inflation will fall as energy price increases fall out of the annual data over the next few months, but the underlying level of inflation is still a concern.
I think the strength of the economies here, in the US, Europe and elsewhere has been surprising and encouraging. However, the rest of the year is a concern; the data is not unequivocally positive and we are reading about the plight of the consumer in the press as mortgage rates rise and the cost of food and clothes continues to spike.
An economic slowdown would be the expected result of the necessary policy measures that have been applied and a recession, of one sort or another, is on the cards.
That doesn’t sound good for financial markets
Investors take future expectations into account when making investment decisions and therefore the prices of different types of assets; bonds, shares, gold etc, should reflect that, this is sometimes called “discounting”. In other words, financial markets discount the expectations for inflation, interest rates, economic growth and company profits amongst many other variable factors.
That means, theoretically, they are always valued at about the correct level. But, as we know, that’s the theory and the practicality is usually different.
At present, in my view, market levels are discounting that interest rates may well have peaked and could be falling, inflation is under control and any significant recession will be avoided. I fear it may not pan out like that. Therefore, some caution is advisable.
However, the fall in bond prices we have seen since early in 2022 has meant that the returns now available for the risk being taken are much more attractive and areas of the bond market look good value to us. Similarly, when speaking to the managers of our equity funds, they are all finding interesting companies in which to invest, furthermore, company profitability is holding up quite well. We can find many opportunities across all asset classes. But this is for the long term, the short term is the concern.
As we all know, investing is for the long-term and that is the approach we should take.
The last word
For several years now, financial markets have been driven by “macro” factors; inflation, economic growth and the like. This can result in investors focusing on specific traits and that has manifested itself in buying the “FAANGs”, the largest US technology and communications companies such as Apple, Amazon, Alphabet (Google), Meta (Facebook), Netflix, Microsoft, Nvidia and similar. This took place in the low inflation, low interest rate, low growth period through the 2010’s and through COVID, when the relatively strong growth in profits and revenues that these companies offered were much sought after. As we approach the peak in interest rates and worry about economic growth prospects now, company profits are at risk, therefore, the same factors are at work and the FAANGs share prices have performed very well so far this year.
Arguably, these companies have got to levels of valuation that are eye watering. Their share prices have risen much more sharply than their profits, which makes them more expensive than they were on different valuation measures. Importantly. they are large components of numerous stock market indices, such as the S&P 500 Index in the US and the MSCI World Index and drive these indices higher as their share prices rise. Many other companies whose businesses continue to do well fundamentally are left behind or ignored and their valuations appear low.
I look forward to us getting back to the time when fundamentals drive company share prices, not the macro factors.
