We hope you are keeping well and enjoying these relatively benign autumn temperatures? Conditions have been less comfortable in Downing Street last month of course, as Liz Truss unceremoniously left office, to be replaced by the seemingly steadier and more experienced Rishi Sunak. It is too early to make bold claims about the likely success or failure of Sunak’s policy agenda, but it does seem the phase of peak market panic is now behind us. The legacy of higher mortgage rates persists, but is clearly now a barometer of economic and, therefore, political success, and one might expect policy to adjust accordingly…. We shall see!?

Returning to markets and although year to date returns remain uninspiring, investors have at least enjoyed a better month in October; with major developed equity and bond markets delivering positive performance. Even UK assets, amidst the ongoing political soap opera, were able to post gains.

Many investors will be quick to categorise October’s resilience as a ‘bear market rally’ however, and an alluring but ultimately temporary feature of a more dominant downward trend. And it is hard to dismiss such claims as the challenges which have plagued markets this year, that of persistently high inflation, aggressive central banks and anxieties surrounding growth expectations, remain. Indeed, for markets to move beyond the ‘bear market rally thesis’, investors might first need to see a reversal, or the prospect of a reversal, in each of these forces.

Such an outcome might not be such a distant hope, however. With commodity prices off their highs, and year over year base effects starting to dampen their contribution to the inflation calculation, evidence that inflation is passing its peak is starting to emerge, particularly in the US. What is more, as the pandemic moves further into the past, resolutions to supply chain frictions and a general switch from buying goods to consuming services may place further downward pressure on prices.

We concede a U-turn in Central Bank strategy, akin to those we have seen in political circles of late, is unlikely. However, a less aggressive approach to policy execution may be all that’s needed to remove investor’s worst fears surrounding growth outcomes and bring some much-needed relief to sentiment. Any cracks that appear in the labour market, which have remained so robust to date, would give further cover for central banks to pursue a more forgiving approach.

As you should expect, however, there are certainly risks to this view, not least when analysing commodity prices. It would, for example, be pretty heroic to ignore the material threat of higher energy prices as the conflict on Europe’s Eastern flank threatens broader escalation.

With elevated risks surrounding the path for inflation and policy, therefore, equities could be a difficult hold in the months ahead. Indeed, the damage inflicted by the sharp ascent already in interest rates, along with the high and persistent level of inflation, may have already set the US on course for a more troubling economic outcome. But an extended downturn needn’t be the base case however, given the aggregate health of household balance sheets and the absence of corporate excesses compared to previous cycles.

It should also be worth noting that valuations are far less demanding than at the turn of the year. We acknowledge valuations are a pretty weak signal in the short-term, however, long-term investors might well consider this a relatively attractive development.

Yet despite this more positive view, we reiterate the fragility of the global economy. Inflationary risks persist and central bankers’ willingness to defeat it should not be understated. At this point we should also highlight the ongoing challenges that China presents to the global economy. The Chinese commitment to a Zero Covid policy and ‘Common Prosperity’ are noble in their ambition, and it would be callous to suggest otherwise. However, shutting down areas of the economy and seeking a more aggressive redistribution of profits are not a particularly fertile mix for an enduring stock market recovery. The issue is aggravated further by a housing market that remains extremely weak and enjoying only limited stimulus. Such a troubling backdrop is well understood by investors, however, so signs of a reversal in policy/fortune in any of these areas could bring sharp relief to the associated markets.

Given such uncertainty, as well as our philosophical recognition of the need for humility when investing, portfolios strive to seek appropriate levels of diversification. Relative to stocks, high quality corporate and even government bonds might offer a more defensive return profile in the face of less encouraging growth outcomes, particularly given this year’s move higher in yields. Alternative asset classes also help diversify portfolios in a more challenging period for stock markets.

Stay safe, stay well, and please get in touch if you wish to discuss any part of your portfolio investment strategy further.

Kind regards,

iPensions Wealth Team

Investment risks

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