We hope you are keeping well and are preparing yourselves adequately for the festive season and enjoy some well-earned downtime (and calories) after something of an annus horribilis. In a year so sparse of good news it has, at least, been pleasing to observe the equity market recovery in October, continued through November. In fact, UK stock markets, which enjoyed particularly eye-catching returns over the month, now sit in positive territory for the year, with the FTSE 100 even finishing November at a 2022 closing high.

Many investors will be quick to categorise the stock market resilience as a ‘bear market rally’ – an alluring but temporary feature of a more dominant downward trend. It is hard to dismiss such claims as the challenges 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. But might this very outcome be playing out before us?

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. This is particularly the case in the US where, though it is still too early to call it a ‘trend’, the most keenly watched inflation data has started to move lower. And this is particularly important as investors tend to most closely follow US data given its dominant economic position. On that basis, therefore, we would also point to more recent US releases on house prices, rental agreements and even wages, which further support a gradual fading of the inflationary threat.

We would concede the much romanticised ‘pivot’ in central bank strategy, where policy shifts from hiking interest rates to cutting them, does not seem an imminent prospect; levels of inflation still seem too high, and the labour market too strong, for that. However, a lower increment in the execution of hikes is seemingly removing investor’s worst fears surrounding growth outcomes and offering some much-welcome relief.

Should softening inflation data persist therefore, and/or any cracks appear in the labour market, then further cover for central banks would be provided to pursue a more forgiving approach which, in turn, might propel recovering sentiment and share prices yet higher.

But whilst this modification in monetary policy is currently supporting markets, our fear is attention may soon ‘pivot’ to the level of interest rates, rather than their incremental change. It would seem likely, given the communication strategy from central banks, that interest rate policy will soon move into restrictive territory, if it’s not there already. Should such an outcome prevail (and persist), the risk of recession would rise materially. Indeed, this is already the base case for many investors.

A UK and European recession seem more probable, but a US recession is not a certainty, not least if inflation falls fast enough and the policy response is so generous as to prevent it. The strength of the jobs market and the high level of US savings might also support consumption and ward off a more troubling downturn too. Nevertheless, recessionary risks are elevated, and investors should steel themselves for volatility ahead.

But again, we would argue all is not lost for equity investors. A recession that is so widely predicted may not inflict the same damage as one that catches investors off-guard. The recession may not be so severe either given the apparent absence of major economic imbalances i.e., banks, corporations and households don’t (in aggregate) appear to be shouldering quite so much debt as in past more devastating recessions.

We should also remind ourselves that, having moved off the zero bound, there are now some interest rates to cut! Again, this policy flexibility might prevent a more pernicious downturn and prove sufficient to reignite economic and investor enthusiasm.

Recognising the outlook remains uncertain, as well as our philosophical belief in the need for humility when investing, portfolios strive to seek appropriate levels of diversification to meet the investment challenges ahead. Relative to stocks for example, 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 assist efforts to help diversify portfolios in a more troubling period for stock markets.

Finally, let me please wish you all a wonderful holiday season and a prosperous New Year, and offer a reminder that should you wish to discuss any part your portfolio investment strategy further, then please just reach out to us.

Kind regards,

iPensions Wealth Team

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